Morningstar DBRS Confirms Toronto Hydro Corporation’s Issuer Rating at “A” With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed Toronto Hydro Corporation's (Toronto Hydro or the Company) Issuer Rating and Senior Unsecured Debentures & MTNs rating at "A" and the Company's Commercial Paper rating at R-1 (low). All trends are Stable.

KEY CREDIT RATING CONSIDERATIONS
Toronto Hydro's credit ratings are based on the Company's stable regulated electricity distribution business, which operates under a reasonable regulatory environment under the Ontario Energy Board (OEB). In November 2023, Toronto Hydro filed its 2025-29 Custom Incentive Rate-setting (IR) application with the OEB. The Company's application includes a significant capital expenditures (capex) plan of $3.9 billion (compared with $2.9 billion approved for 2020-24) to replace aging infrastructure, modernize the grid, and prepare for expected growth in demand from electrification.

CREDIT RATING DRIVERS
Morningstar DBRS considers a positive credit rating action as unlikely at this time given the capex program in place and the current business risk assessment. A negative credit rating action may occur should the Company's key credit metrics weaken to a level no longer commensurate with the "A" credit rating category for a sustained period of time (cash flow-to-debt less than 12.5%, debt-to-capital more than 65.0%, and EBIT-interest coverage less than 1.80 times).

FINANCIAL OUTLOOK
As a result of its already large capex program, Toronto Hydro's key credit metrics have weakened over the past few years. While the Company's financial risk assessment continues to remain supportive of the current "A" credit rating, Morningstar DBRS expects Toronto Hydro's capex program will require substantial debt financing, which may lead to further weakening in key credit metrics. Morningstar DBRS expects Toronto Hydro to manage its debt load and dividend payments (distribution policy of 60% of consolidated net income after net movements in regulatory balances) in order to maintain leverage in line with the regulatory capital structure of 60% debt. Morningstar DBRS notes that the Company's leverage already increased to 61.5% for 2023, and cash flow-to-debt weakened to 11.8%. Morningstar DBRS will review Toronto Hydro's capex and financing plans following the approval of its 2025-29 Custom IR application. Should the Company's key credit metrics further weaken to below the "A" credit rating category, a negative credit rating action is likely to occur.

EARNINGS OUTLOOK
Toronto Hydro's earnings have been relatively stable, supported by its regulated operations and the decoupling of distribution rates for residential customers. However, net income has been negatively affected by higher interest expense and inflationary pressure on operating expenses, and lag in passing through this impact to customers. As such, Morningstar DBRS expects the Company's EBITDA and EBIT to weaken modestly in 2024, but for net income to notably decrease. Morningstar DBRS expects Toronto Hydro's earnings to recover in 2025 following the approval of its Custom IR application. Overall, Morningstar DBRS expects earnings to increase modestly year over year from growth in the rate base.

CREDIT RATING RATIONALE
Toronto Hydro's credit ratings are supported by the reasonable regulatory framework and a strong and growing franchise area. This is offset by balance sheet pressures as a result of high capex, earnings being sensitive to volume, and limited access to equity markets.

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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of Toronto Hydro, the BRA factors were considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of Toronto Hydro, the FRA factors were considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of Toronto Hydro, the BRA carries greater weight than the FRA.

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Companies in the Regulated Utility and Independent Power Producer Industries (April 15, 2024), https://dbrs.morningstar.com/research/431184

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186, which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

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 info-DBRS@morningstar.com.

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.

Morningstar DBRS had access to the accounts, management, 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. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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