Morningstar DBRS Confirms CU Inc.'s Issuer Rating at A (high), Stable Trend

DBRS Limited (Morningstar DBRS) confirmed CU Inc.'s (CUI or the Company) Issuer Rating and Unsecured Debentures & Medium-Term Notes rating at A (high). Morningstar DBRS also confirmed the Company's Commercial Paper rating at R-1 (low) and Cumulative Preferred Shares rating at Pfd-2 (high). All trends are Stable. The Stable trends reflect CUI's solid credit metrics and strong financial flexibility as well as the expectation that the Company will finance its capital expenditures (capex) in a manner that will maintain leverage consistent with the regulatory capital structure.

KEY CREDIT RATING CONSIDERATIONS
CUI's credit ratings are largely based on the Company's low-risk diversified regulated natural gas and electricity transmission and distribution operations in Alberta, Canada. The transmission operations are under cost of service (COS), allowing the Company to recover prudently incurred costs and earn a regulated return on investments. The distribution businesses operated under a one-year COS framework in 2023 and the third-generation Performance-based Regulation (PBR) in 2024-28. Morningstar DBRS views the Alberta Utilities Commission's (AUC) regulatory framework as generally supportive. CUI's financial risk assessment remains supportive of its ratings, and the Company has consistently maintained its operating efficiency to achieve returns above its allowed return on equity (ROE).

In November 2023, the AUC approved a 9.28% ROE for 2024 for Alberta utilities under a new formulaic approach, which Morningstar DBRS views as modestly positive for reducing regulatory lag. In October 2023, the AUC issued its decision for the third-generation PBR; Morningstar DBRS is of the view that the new parameters largely mirror the previous plan and will not have a material impact on the Company's earnings and cash flow. In June 2023, the AUC initiated a review under the reopener provision of the second-generation PBR for ATCO Electric and ATCO Gas (the Company's distribution operations). This review was triggered because the actual ROE for each utility exceeded the reopener thresholds of 300 basis points (bps) approved ROE in 2021 and 2022, and the thresholds of 500 bps for 2022. Morningstar DBRS notes that such a review is a standard procedure within the PBR plan, and the impact will be reviewed once the final decision has been made.

CREDIT RATING DRIVERS
A positive rating action is unlikely in the medium term given the stability of the current business risk profile and the planned increase in capital expenditure. A negative rating action may occur should the Company's key credit metrics decline to a level no longer supportive of the current ratings (such as cash flow-to-debt below 12.5% and debt-to-capital above 65%).

EARNINGS OUTLOOK
CUI's earnings have benefited from rate base expansion and continued efficient operations. Lower earnings in 2023 are primarily due to the cost efficiencies achieved during the second-generation PBR now being passed on to the customers (efficiency carryover). Morningstar DBRS expects the Company's earnings to improve modestly in 2024, driven by a higher allowed ROE of 9.28% for the year and growth in rate base, partially offset by the efficiency carryover of the previous PBR.

FINANCIAL OUTLOOK
CUI's key credit metrics are supportive of the current ratings. Morningstar DBRS expects the Company's credit metrics to remain in line with the "A" rating category over the medium term. The Company has projected capex of approximately $1.2 billion in 2024, increasing to $1.5 billion in 2025, and further stepping up to $2 billion in 2026 when the construction of the Yellowhead Mainline project commences. Morningstar DBRS believes that the Company has the financial flexibility to handle this increased capex. Once more details about the funding plan and cost recovery mechanism for the Yellowhead Mainline project become available, Morningstar DBRS will evaluate the impact on credit metrics.

CREDIT RATING RATIONALE
CUI's credit ratings are underpinned by the Company's (1) generally supportive regulatory framework under the AUC, (2) large size and diversified business lines, and (3) solid credit metrics. This is partly offset by regulatory risk, such as stranded asset risk associated with the Utility Asset Disposition policy.

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 CUI, the BRA factors were considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of CUI, 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 CUI, 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 (June 27, 2024), https://dbrs.morningstar.com/research/435127

The following methodology has also been applied: Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186.

The following criteria has also been applied:
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030.

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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