Morningstar DBRS Confirms ATCO Ltd.'s Issuer Rating at A (low), Stable Trend

DBRS Limited (Morningstar DBRS) confirmed ATCO Ltd.'s (ATCO or the Holdco) Issuer Rating at A (low) and Fixed-to-Floating Rate Subordinated Notes (the Subordinated Notes) rating at BBB. The trends on both credit ratings are Stable. The confirmations reflect (1) ATCO's solid consolidated metrics, strong liquidity, and low leverage at the Holdco level; (2) the strong and stable credit profile at its sizable and diversified regulated subsidiaries owned indirectly through Canadian Utilities Limited (CUL; rated "A" with a Stable trend by Morningstar DBRS); and (3) modest exposure to nonregulated business, which is unlikely to increase significantly in the medium term. ATCO owned 52.6% of CUL as at June 30, 2024.

KEY CREDIT RATING CONSIDERATIONS
ATCO's credit ratings are largely based on the credit quality of CUL, in which ATCO holds a 52.6% ownership stake; structural subordination to the debt of its operating subsidiaries; and modest exposure to nonregulated business.

CUL's business risk profile, which accounts for approximately 90% of ATCO's consolidated EBITDA (on a five-year average), remains stable. CUL's predominant operations are regulated electricity transmission, electricity distribution, natural gas transmission, and natural gas distribution in Alberta, where there is a reasonable regulatory regime. The regulated nature of CUL's operations provides ATCO with predictable and steady cash flows, benefiting ATCO's credit metrics. On August 28, 2024, Morningstar DBRS confirmed its "A" credit rating on CUL. Please see Morningstar DBRS' press release for details.

ATCO's credit ratings also incorporate its modest exposure to the higher-risk business at ATCO Structures & Logistics Ltd. (ASL) and a 40% equity investment in Neltume Ports in Chile. Morningstar DBRS considers ASL's modular construction business to be cyclical and operating in a highly competitive market. Overall, nonregulated activities, including CUL's industrial water and energy infrastructure and services, have been gradually increasing over the past years and were contributing around 14% of consolidated EBITDA as of June 30, 2024, according to Morningstar DBRS estimates.

Based on ATCO's current business plans, CUL's credit ratings will likely continue to form the basis for ATCO's credit ratings. Morningstar DBRS believes that if the proportion of nonregulated business rises, variability in earnings and business risk will likely increase. Any significant changes in business portfolio, market conditions, or operational performance will be key factors in future credit rating assessments and could potentially lead to Morningstar DBRS taking a negative credit rating action.

CREDIT RATING DRIVERS
Morningstar DBRS is unlikely to take a positive credit rating action in the medium term, given the stability of the current business risk profile and the fact that the credit ratings are largely constrained by CUL's credit ratings. A negative credit rating action would be possible if (1) Morningstar DBRS took a negative credit rating action on CUL; (2) the Holdco increased investments in nonregulated operations that permanently shifted its business risk (measured by nonregulated operations contributing more than 20% of EBTIDA on a sustained basis); or (3) ATCO's consolidated credit metrics declined to a level no longer supportive of the current credit ratings (such as cash flow-to-debt below 12.5% and debt-to-capital above 60%).

EARNINGS OUTLOOK
ATCO's earnings have benefitted from predicable earnings from its regulated operations. Earnings in 2023 were stronger than in previous years, reflecting improved performance from ASL, which largely benefitted from increased space rentals activity in most geographies and additional earnings from recent acquisitions, partially offset by slightly lower contributions from regulated utilities as a result of the cost efficiencies that its regulated utilities in Alberta achieved during the second-generation performance-based regulation now passed on to customers (efficiency carryover). Morningstar DBRS expects earnings to see modest increases year over year, in line with the growth in the rate base, with fluctuations largely from nonregulated operations.

FINANCIAL OUTLOOK
ATCO's consolidated credit metrics are solid for its current "A" credit rating category. Morningstar DBRS notes that the near-term elevated capital expenditures (capex) will largely be allocated to ATCO's regulated utilities and should not materially shift its current business mix. Morningstar DBRS expects, for the medium term, (1) ATCO's consolidated cash flow-to-debt to remain stable within the 13% to 16% range; (2) consolidated debt-to-capital to increase modestly, underpinned by the regulatory approved deemed equity (37% in Alberta and 45% in Australia); and (3) Holdco leverage to remain low, as CUL and its regulated utilities have the financial flexibility to self-finance the capex.

CREDIT RATING RATIONALE
ATCO's credit ratings are supported by the strong credit quality of its regulated operations as well as solid consolidated credit metrics, minimal Holdco debt, and strong liquidity; however, modest exposure to nonregulated businesses and regulatory risks in Alberta and Australia partially offset these factors . Additionally, the structural subordination of ATCO's debt to the debt at its operating subsidiaries constrain the Holdco's credit ratings, 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 ATCO, the BRA factors were considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of ATCO, 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 ATCO, 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 criteria has 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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