DBRS Morningstar Confirms Newfoundland Power Inc. at “A” with Stable Trends

DBRS, Inc. (DBRS Morningstar) confirmed Newfoundland Power Inc.’s (Newfoundland Power or the Company) Issuer Rating and First Mortgage Bonds rating at “A.” All trends are Stable. The ratings are supported by the Company’s stable regulated operations, mainly consisting of electricity distribution; the reasonable regulatory regime under the Board of Commissioners of Public Utilities (PUB); and a solid financial profile.

Newfoundland Power is regulated under cost-of-service regulation by the PUB and continues to benefit from multiple regulatory deferral accounts, reducing volatility in earnings and cash flow. Effective March 1, 2022, the PUB approved an effective decrease of 1.1% in electricity rate charges to customers, and the Company is required to file its next General Rate Application on or before June 1, 2024.

RATING RATIONALE/DESCRIPTION
DBRS Morningstar considers the biggest challenge Newfoundland Power faces to be the potential rate shock for ratepayers from the Muskrat Falls Project, an 824-megawatt hydroelectric generating facility developed by Nalcor Energy that is expected to be fully commissioned by the end of 2022. The full commissioning of the Muskrat Falls Project is dependent on the testing and commissioning of control software associated with the Labrador Island Link (LIL) transmission line from Muskrat Falls in Labrador to Soldiers Pond on Newfoundland’s southeast coast. At project completion, a rate shock could severely reduce electricity volumes and affordability for Newfoundland Power's customers and negatively affect the Company’s earnings and cash flow. In February 2022, the Province of Newfoundland and Labrador (the Province; rated A (low) with a Stable trend by DBRS Morningstar) and the Government of Canada (rated AAA with a Stable trend by DBRS Morningstar) finalized an agreement in principle for the financial restructuring of the Muskrat Falls Project. The new finalization involves term sheets for a $1 billion federal loan guarantee and a $1 billion investment by the Government of Canada in the Province’s portion of the LIL. The timing and the final impact the agreement will have on customer rates remains uncertain. Although DBRS Morningstar views this as a positive development, the uncertainty on future rates remains. DBRS Morningstar will continue to monitor the situation and treat a potential rate shock as an event risk.

DBRS Morningstar views weak provincial economic conditions with high dependence on volatile commodity prices as another challenge because it could significantly affect the affordability for Newfoundland Power's customers. The Province’s economic and fiscal performance heavily depend on the resource sector, with resource royalties accounting for 8% to 31% of government revenue over the past decade. This figure does not include a meaningful amount of other revenue indirectly derived from related activities. However, DBRS Morningstar notes that provincial economic conditions have improved compared with the previous year because of higher oil prices and high vaccination rates. Nevertheless, DBRS Morningstar believes that the Company's strong financial profile provides enough flexibility to absorb any short-term negative impacts on cash flow to support the current ratings.

Newfoundland Power’s key credit metrics remained solid for the current ratings in 2022 and for the last 12 months ended June 30, 2022. The Company’s earnings and cash flow from operations have largely remained steady year over year, reflecting the stable nature of its operations. Newfoundland Power is expected to have moderate free cash flow deficits for the next few years because of the maintenance and growth capital spending along with dividend payout. DBRS Morningstar expects the Company to manage these deficits prudently to maintain leverage in line with the regulatory capital structure, allowing key credit metrics to stay within the current rating category.

A positive rating action for the Company is unlikely in the near to medium term because of the weaker franchise area and uncertainty regarding the rate impact from the Muskrat Falls Project, which is still awaiting completion. Although unlikely, if ratepayers’ ability to pay bills or Newfoundland Power’s ability to fully pass on costs is negatively affected, DBRS Morningstar may downgrade the Company’s ratings by multiple notches. However, DBRS Morningstar gains some confidence because, as of July 1, 2022, Newfoundland Power customers started paying for a portion of Muskrat Falls Project-related costs through Newfoundland and Labrador Hydro’s (NLH; rated A (low) with a Stable trend by DBRS Morningstar) Muskrat Falls Project Cost Recovery Rider. Full recovery of Muskrat Falls Project costs will occur following the finalization of all Muskrat Falls Rate Mitigation plans and NLH’s next General Rate Application.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) 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 principal methodology is Global Methodology for Rating Companies in the Regulated Electric, Natural Gas, and Water Utilities Industry (September 13, 2022; https://www.dbrsmorningstar.com/research/402616), 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 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.

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

DBRS Morningstar will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at [email protected].

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

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