DBRS Morningstar Confirms TransAlta Corporation at BBB (low) and Pfd-3 (low) With Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Unsecured Debt/Medium-Term Notes credit rating of TransAlta Corporation (TAC) at BBB (low) and TAC’s Preferred Shares credit 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.

DBRS Morningstar notes that on October 5, 2023, TAC announced that it acquired the 40% stake of TransAlta Renewables Inc. that it did not previously own. In November 2023, TAC entered into a definitive share purchase agreement with an affiliate of Energy Capital Partners, the parent of Heartland Generation Ltd. and Alberta Power (2000) Ltd. (collectively, Heartland). For additional details, please see DBRS Morningstar’s press releases dated July 11, 2023, and November 2, 2023, respectively.

The Province of Alberta's (Alberta; rated AA with a Stable trend by DBRS Morningstar) merchant spot electricity prices decreased to $152 per megawatt hour (MWh) in Q3 2023, compared with $221 MWh in Q3 2022. TAC's Alberta hydroelectric facilities, which represent more than 90% of Alberta's hydro generation plants, were able to benefit from the strong merchant prices. The Alberta hydroelectric assets generated approximately 28% of TAC's consolidated adjusted EBITDA in last 12 months ended September 30, 2023. 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 approximately 11 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 credit ratings incorporate the structural subordination of TAC's debt to the nonrecourse debt at its projects and subsidiaries. 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. However, DBRS Morningstar notes that if the project-level debt increases significantly, structural subordination could become a greater concern, which could result in a negative credit rating action.

The Stable trends reflect DBRS Morningstar's view that (1) the exposure to merchant risk in Alberta for 2024 is well hedged and (2) TAC’s business risk and 2024 consolidated credit metrics are likely to continue supporting the current credit ratings. DBRS Morningstar does not expect to take any positive credit rating action in the near to medium term. However, a negative credit rating action could occur if (1) Alberta has a sustained weakening in its power market, (2) the current contractual profile deteriorates materially, or (3) the consolidated cash flow-to-debt ratio falls below 17.5% 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/416784 (July 4, 2023).

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

DBRS Morningstar applied the following principal methodologies:
-- Global Methodology for Rating Companies in the Independent Power Producer Industry (https://www.dbrsmorningstar.com/research/413646; May 9, 2023)
-- DBRS Morningstar Global Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (https://www.dbrsmorningstar.com/research/422134; October 19, 2023)

The credit 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.

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 credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit 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 credit rating action.

This is a solicited credit rating.

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 credit ratings are under regular surveillance.

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

Information regarding DBRS Morningstar credit ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at [email protected].

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