DBRS Morningstar Confirms Hydro Ottawa Holding Inc. at A (low), Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Senior Unsecured Debt rating of Hydro Ottawa Holding Inc. (Hydro Ottawa or the Company) at A (low). Concurrently, DBRS Morningstar confirmed the rating of Hydro Ottawa's commercial paper program at R-1 (low). All trends are Stable. The confirmations reflect the continued strength and stability of the Company’s regulated electricity distribution operations, its steady performance and demonstrated recovery from the effects of the Coronavirus Disease (COVID-19) pandemic, and its reasonable financial risk profile. These are increasingly offset by its portfolio of nonregulated businesses, primarily power generation assets that DBRS Morningstar views as riskier than the regulated business, and whose contribution to Hydro Ottawa’s total EBIT is likely to remain at or above 30% on a continued, structural basis. This sustained increase in EBIT contribution from generation assets was the basis for the downgrades DBRS Morningstar took in 2020. In addition, the Company continues to put increased commercial focus on Envari, Hydro Ottawa’s energy services division, and it recently launched Hiboo Networks Inc., a wholesale telecommunications optical fibre business, which, together with the power generation, could further increase the proportion of nonregulated businesses in the revenue mix.

Nevertheless, Hydro Ottawa’s overall business risk profile continues to benefit from its stable regulated electricity distribution operations in the City of Ottawa (100% owner of Hydro Ottawa), which was most recently amply demonstrated during the pandemic. Although the Company’s management has determined Hydro Ottawa is not eligible for coronavirus-related deferral accounts set up by the Ontario Energy Board to help Ontario utilities recover pandemic-related losses, the impact of this is muted by Hydro Ottawa’s resilience to the effects of the pandemic over 2020 and 2021. The largest impacts of the pandemic were an increase in payment arrears at the height of the lockdown, a relatively minor incurrence of just above $4 million in pandemic-related expenses, and a moderate delay of several months to the Hull Energy refurbishment project.

Hydro Ottawa’s financial risk profile weakened between 2018 and 2021 because of the Company’s large capital expenditure program for maintaining its distribution infrastructure, connecting new customers, and refurbishing generating facilities at Chaudière Hydro North and Hull Energy, which temporarily reduced revenue from these two sites. With the completion of the refurbishments to Chaudière Hydro North in early 2020 and Hull Energy in mid-2021, full distributions from the projects are now beginning to accrue to the Company. Additionally, the $290.5 million secured notes issued to fund the refurbishments have now become nonrecourse to the Company, and they are secured by the generating assets themselves (although on a consolidated basis, these continue to be recorded on the Company’s balance sheet), while Hydro Ottawa’s 2021 launch of its commercial paper program is helping to reduce short-term borrowing costs.

The Company’s stability is partly offset by its growing portfolio of nonregulated electricity generation assets and its expanding energy services business (and eventually, its telecommunications business). The electricity generation portfolio is largely supported by annually escalated fixed-price power purchase agreements with the Independent Electricity System Operator, but DBRS Morningstar notes this business segment does involve higher volume and operational risk, leading to more volatile earnings and cash flows. Certain generation offtake contracts, notably those in the state of New York, are also subject to a degree of merchant risk. Energy services are characterized by relatively long-term service contracts of several years’ duration with strong public-sector counterparties, providing a degree of revenue stability over the term of the contracts; however, to maintain or grow services revenue on a consistent basis, Envari must demonstrate it can secure new contracts as current ones roll off.

DBRS Morningstar will monitor the increasing mix of nonregulated revenue from all sources in its assessment of Hydro Ottawa’s business fundamentals. If the nonregulated business’ EBIT contribution increases materially above the current level, a negative rating action could occur. Additionally, negative rating actions may occur should the Company’s key credit metrics deteriorate to a level no longer commensurate with the current rating category, considering the mix of the regulated and nonregulated businesses. Factors leading to a ratings upgrade are not currently likely.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no environmental, social, and governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

Notes:
All figures are in Canadian dollars unless otherwise noted.

The methodologies are Rating Companies in the Independent Power Producer Industry (May 18, 2022; https://www.dbrsmorningstar.com/research/396971), Global Methodology for Rating Companies in the Regulated Electric, Natural Gas, and Water Utilities Industry (September 13, 2022; https://www.dbrsmorningstar.com/research/402616), and DBRS Morningstar Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (March 1, 2022; https://www.dbrsmorningstar.com/research/393065), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223/interplay-of-global-corporate-finance-rating-methodologies-when-analyzing-corporate-finance-transactions.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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