DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Unsecured Debt/Medium-Term Notes rating of TransAlta Corporation (TAC) at BBB (low) and TAC’s Preferred Shares rating at Pfd-3 (low). The trends are Stable. The confirmations reflect TAC's (1) reasonable contractual profile, (2) low fuel risk and cost competitiveness, and (3) operational expertise. These strengths are partially offset by (1) merchant generation risk, (2) structural subordination of cash flows, and (3) expansion risk.
The Province of Alberta’s (Alberta; rated AA (low) with a Positive trend by DBRS Morningstar) merchant spot electricity prices increased to $162 per megawatt hour (MWh) in 2022, compared with $102 MWh in 2021. TAC's Alberta hydroelectric facilities, which represent more than 90% of hydro generation plants, were able to benefit from the strong merchant prices. The Alberta hydroelectric assets generated approximately 32% of TAC's consolidated adjusted 2022 EBITDA. The strong merchant sales resulted in TAC achieving strong financial metrics for 2022. DBRS Morningstar expects the financial metrics to remain solid over the medium term.
TAC's contract profile remains strong, with more than 90% of TAC's consolidated free EBITDA (after maintenance capital expenditures) coming from either long-term contracts with a weighted-average life of more than 10 years or from hydro generation plants in Alberta. DBRS Morningstar believes TAC currently benefits from the energy-only market in Alberta and from its hydro generation assets. However, TAC's exposure to the power market in Alberta remains a concern because most power-generation assets in Alberta are without long-term power purchase agreements.
DBRS Morningstar notes the ratings incorporate the structural subordination of TAC's debt to the nonrecourse debt at its 100%-owned projects and the debt at TransAlta Renewables Inc. (RNW; 60% owned by TAC). DBRS Morningstar believes the structural subordination is significantly mitigated because most of TAC's modified cash flow comes from assets with no or minimal debt. Currently, the debt at RNW is modest in terms of total consolidated debt. However, DBRS Morningstar notes that if the debt at RNW increases significantly, structural subordination could become a greater concern which could result in a negative rating action.
The Stable trends reflect DBRS Morningstar's view that (1) the exposure to merchant risk in Alberta for 2023 is well hedged and (2) TAC’s business risk and 2023 consolidated credit metrics are likely to continue supporting the current ratings. DBRS Morningstar does not expect to take any positive rating action in the near to medium term. However, a negative rating action could occur if (1) Alberta has a sustained weakening in its power market, (2) the current contractual profile deteriorates materially, (3) RNW's debt and cash flow contribution to TAC's overall cash flow increases significantly, and (4) the overall consolidated credit metrics fall below the BBB range on a consistent basis.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/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 (May 17, 2022).
All figures are in Canadian dollar unless otherwise noted.
The principal methodologies applicable to the rating are Rating Companies in the Independent Power Producer Industry (https://www.dbrsmorningstar.com/research/396971; May 18, 2022) and DBRS Morningstar Global Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (https://www.dbrsmorningstar.com/research/404248; October 20, 2022).
The rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
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.
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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.
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