Morningstar DBRS Confirms Canadian Utilities Limited's Issuer Rating at "A," Stable Trend

DBRS Limited (Morningstar DBRS) confirmed Canadian Utilities Limited's (CUL or Holdco) Issuer Rating and Unsecured Debentures rating at "A." Morningstar DBRS also confirmed CUL's Commercial Paper rating at R-1 (low) and Cumulative Preferred Shares rating at Pfd-2. All trends are Stable. The confirmations reflect (1) CUL's reasonable consolidated metrics, strong liquidity, and low leverage at the Holdco level; (2) the strong credit profile at its sizable and diversified regulated subsidiary, CU Inc. (CUI; rated A (high) with a Stable trend by Morningstar DBRS); and (3) stable cash flow from other regulated operations, including ATCO Gas Australia (AGA) and joint venture investments in LUMA Energy, LLC (LUMA Energy). Regulated operations accounted for most of CUL's earnings and are expected to contribute approximately 90% to 95% of CUL's EBITDA in the medium term. CUL's ratings incorporate the structural subordination of its debt to the debt issued by CUI as well as AGA.

KEY CREDIT RATING CONSIDERATIONS
CUL's credit ratings are largely based on the credit quality of CUI, which accounts for approximately 80% of CUL's earnings. CUI operates low-risk diversified regulated natural gas and electricity transmission and distribution systems in Alberta, with a 2023 mid-year rate base of approximately $14 billion. Morningstar DBRS views Alberta's regulatory framework as generally supportive. CUI has maintained operating efficiencies to achieve returns above its allowed return on equity (ROE). On July 24, 2024, Morningstar DBRS confirmed its A (high) rating of CUI. Please see Morningstar DBRS' report on CUI dated August 7, 2024, for details.

CUL's other regulated operations (10%-15% of earnings) include AGA, which is a regulated natural gas distributor in Western Australia, and a 50% stake in LUMA Energy which operates Puerto Rico's electricity transmission and distribution system under a contract that lasts until 2036. Morningstar DBRS notes that both AGA and LUMA Energy offer modest regulatory diversification while positively affecting CUL's credit profile by providing stable cash flow without additional Holdco debt.

CUL's remaining operations (less than 10% of its earnings) are nonregulated and include electricity generation, industrial water, and natural gas-related infrastructure and services. The acquisition of the renewable power generation from Suncor Energy Inc. in 2023 had no material impact to the mix of regulated and nonregulated operations. Morningstar DBRS is of the view that CUL's nonregulated operations, although risker compared with its regulated operations, do not materially affect CUL's overall credit quality.

Morningstar DBRS believes that CUL's liquidity position at the HoldCo level is strong, supported by strong cash dividends from regulated activities, sizable cash and available facilities, and very low financing needs.

CREDIT RATING DRIVERS
Morningstar DBRS is unlikely to take a positive rating action in the medium term given the stability of CUL's current business risk profile. The ratings are largely constrained by CUL's subsidiary CUI's ratings. A negative rating action may occur should there be (1) Morningstar DBRS took a negative rating action on CUI; (2) business mix changed materially that reduces the cash flow contribution from CUI to CUL's overall consolidated cash flow; or (3) CUL's consolidated credit metrics declined to a level that no longer supports the current ratings (such as cash flow-to-debt below 12.5% and debt-to-capital above 65%).

EARNINGS OUTLOOK
CUL has benefited from predicable earnings from its regulated operations. Morningstar DBRS expects CUL to generate 90% to 95% of EBTIDA from regulated operations in the long term, with earnings growth being in line with the growth in the rate base. For 2024, Morningstar DBRS expects CUL's earnings to remain stable, benefitting from a higher approved ROE at CUI, offset by forecast lower inflation indexing on rate base in AGA.

FINANCIAL OUTLOOK
CUL's consolidated credit metrics are supportive of the current "A" rating category. CUL has projected a capex plan of $4.3 billion to $4.7 billion for regulated operations during the 2024-26 period, which is 30%-40% higher than the previous cycle. Morningstar DBRS believes that CUL's regulated subsidiaries have the financial flexibility to self-finance the elevated capex. For the medium term, Morningstar DBRS expects (1) CUL's consolidated cash flow-to-debt to average around 14%, (2) consolidated debt-to-capital to increase modestly, while being underpinned by the regulatory approved deemed equity (37% in Alberta and 45% in Australia), and (3) a temporary, modest increase in HoldCo debt to fund the ongoing renewable projects and the recently announced Atlas Carbon Storage Hub; however, these should be repaid through internally generated cash flows and project financing proceeds to maintain a low HoldCo leverage.

CREDIT RATING RATIONALE
CUL's credit ratings reflect (1) strong credit quality of its regulated operations, (2) supportive consolidated credit metrics, minimal Holdco debt, and strong liquidity, which are (3) partly offset by regulatory risk. Additionally, the ratings are constrained by the structural subordination of its debt to the debt at its operating subsidiaries, resulting in a one-notch differential.

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 Factors in Credit Ratings (August 13, 2024), at https://dbrs.morningstar.com/research/437781.

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

(B) Weighting of FRA Factors
In the analysis of CUL, 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 CUL, 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 methodologies have also been applied:
-- Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186.
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781.

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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