Morningstar DBRS Assigns Credit Ratings of A (low) with Stable Trends to Milton Hydro Holdings Inc.

DBRS Limited (Morningstar DBRS) assigned an Issuer Rating of A (low) to Milton Hydro Holdings Inc. (MHHI or the Company) and a provisional credit rating of A (low) to MHHI's proposed issuance of up to $65 million in Senior Unsecured Debentures. The trends on both ratings are Stable.

KEY CREDIT RATING CONSIDERATIONS
The ratings of MHHI are based on its ownership of Milton Hydro Distribution Inc. (MHDI), which provides 95% of the Company's earnings. MHDI is a local distribution company regulated by the Ontario Energy Board (OEB). MHHI's ratings are constrained by the small size of its rate base ($112 million in 2023) and customer base (approximately 45,000).

Morningstar DBRS notes MHHI intends to use proceeds from its Senior Unsecured Debentures issuance to refinance existing debt at MHDI. Additionally, debt at the Company's unregulated subsidiary, Milton Energy and Generation Solutions Inc., has been minor ($3.8 million as at December 31, 2023; approximately 6% of consolidated debt). The Company does not intend to issue further debt at its subsidiaries. As such, Morningstar DRBS views MHHI as a consolidated entity with no credit rating impact from structural subordination.

MHDI provides the large majority of MHHI's earnings and cash flows. Morningstar DBRS considers the regulatory framework for MHDI to be reasonable under the "A" rating category. Under the OEB, MHDI is allowed to recover all prudent expenditures and has the opportunity to earn a reasonable return on equity (ROE; 8.66% for 2023 to 2027).

CREDIT RATING DRIVERS
Morningstar DBRS considers a positive credit rating action to be unlikely given the size of MHHI. A negative credit rating action could occur if the Company's key credit metrics fell to a level no longer in line with the "A" rating category for a sustained period of time (i.e., cash flow-to-debt below 12.5%).

EARNINGS OUTLOOK
MHHI's earnings have historically been relatively stable, supported by its regulated operations. However, earnings in 2020-22 were weak because of the impact of the COVID-19 pandemic and because MHDI deferred rebasing in 2021 and 2022 because of changes to its senior leadership team. However, following rebasing in 2023, the Company's earnings have now returned to historical levels. Additionally, Morningstar DBRS notes that, except for the 2019-22 period, MHDI's achieved regulated ROE has generally been in line with the allowed ROE. Given the stability of the regulated business, Morningstar DBRS expects the Company's earnings to be stable over the medium term.

FINANCIAL OUTLOOK
MHHI's key credit metrics have also been in line with the "A" rating category. While the Company's cash flow-to-debt ratio was weak in 2019-22 because of the lower earnings during this period, this has been offset by the stronger EBIT-interest coverage ratio and leverage that were maintained in line with the regulatory capital structure of 60%. Morningstar DBRS notes that leverage also significantly decreased in 2022 as MHHI used part of the proceeds from the sale of land to pay down debt. Following rebasing in 2023, the Company's cash flow-to-debt metric has now recovered to a level consistent with the "A" rating category. Morningstar DBRS expects future cash flows to be stable, reflecting the regulated nature of MHHI's operations. Additionally, the Company's dividend policy is reasonable (40% of the previous year's net income) and capital expenditures are not expected to be significant (an average of $10 million for the next four years), which should help stabilize key credit metrics. Morningstar DBRS notes that the Senior Unsecured Debentures issuance will be debt neutral to the consolidated financials of MHHI as proceeds will be used to repay debt at MHDI.

CREDIT RATING RATIONALE
MHHI's ratings are supported by its stable regulated operations and strong financial profile. This is partly offset by its small size and performance pressure under the Price Cap Incentive Rate-setting method.

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 MHHI, the BRA factors are considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of MHHI, the FRA factors are considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of MHHI, 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.

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 following methodologies have also been applied:
-- Morningstar DBRS Global Corporate Criteria (April 14, 2024), https://dbrs.morningstar.com/research/431186; and
-- 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.

A provisional credit rating is not a final credit rating with respect to the above-mentioned security and may change or be different than the final credit rating assigned or may be discontinued. The assignment of the final credit rating on the above-mentioned security is subject to receipt by Morningstar DBRS of all data and/or information and final documentation that Morningstar DBRS deems necessary to finalize the credit rating.

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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