Morningstar DBRS Confirms Newfoundland Power Inc. at "A" With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating and the First Mortgage Bonds rating of Newfoundland Power Inc. (Newfoundland Power or the Company) at "A" with Stable trends.

KEY CREDIT RATING CONSIDERATIONS
Newfoundland Power's ratings are based on its stable regulated electricity operations, mainly consisting of electricity distribution, the reasonable regulatory framework under the Board of Commissioners of Public Utilities (PUB), and key credit metrics that have been in line with the "A" credit rating range.

Newfoundland Power is regulated by the PUB under a cost-of-service framework where the Company can recover all prudent expenditures and has an opportunity to earn a reasonable return on rate base. The PUB has also approved the use of several regulatory accounts, such as the Rate Stabilization Account (RSA), to absorb fluctuations and pass-through purchased power costs. Historically, the PUB has approved the Company disposing of the balance in the RSA annually, with the amounts then recovered in rates over the next year. In July 2024, the PUB issued an order on Newfoundland Power's 2024 RSA application, approving a 7% rate increase effective August 1, 2024, consisting effectively of (1) 2.3% for Newfoundland and Labrador Hydro's (Hydro) Rate Stabilization Plan and the Muskrat Falls Project Cost Recovery Rider as outlined in the Province of Newfoundland and Labrador's (the Province; 100% owner of Hydro; both rated "A" with Stable trends) rate mitigation plan, and (2) the remaining 4.7% to clear a portion of the amount in the Company's RSA also related to purchased power costs. This order, however, effectively leaves a $19 million balance in Newfoundland Power's RSA that will have to be recovered later.

Morningstar DBRS had noted the potential risk of costs associated with the Muskrat Falls project leading to a rate shock for Newfoundland Power's customers and was concerned that upward pressure on rates could affect the Company's ability to pass on costs. Morningstar DBRS is satisfied that, with the Province's rate mitigation plan now in place limiting residential rate increases to 2.25% annually until (and including) 2030 for the recovery of Muskrat Falls costs, the probability of rate shock associated with Muskrat Falls has been reduced. However, Morningstar DBRS remains concerned about current rate pressure and that future rate increases for recovery of Newfoundland Power's costs may be more challenging. In August 2024, the PUB did not approve the Company's application for its 2024 rate of return on rate base, but requested that the revenue shortfall, which has largely been because of increases in debt costs, be deferred to the RSA and recovered in a future period. The Company also filed its 2025-26 General Rate Application (GRA) in December 2023, requesting an overall rate increase of 5.5%; the PUB's decision is expected by the end of 2024.

Morningstar DBRS notes that the PUB has not specifically denied the recovery of the amounts in the RSA but deferred their recovery. Newfoundland Power has also proactively addressed any liquidity concerns about carrying the extra balance by increasing its credit facility by $30 million. However, if the recovery of purchased power costs and the Company's other costs of service continue to be delayed in future and ongoing rate cases, Morningstar DBRS may lower the score on the Energy Cost Recovery and Capital and Operating Cost Recoveries considerations in its assessment of the regulatory framework.

CREDIT RATING DRIVERS
A positive credit rating action is unlikely because of the weaker franchise area and rate pressure. A negative credit rating action could occur if Newfoundland Power's ability to fully pass on costs was negatively affected.

EARNINGS OUTLOOK
Newfoundland Power's earnings have been relatively stable because of the regulated nature of the Company's operations. Net income historically increased modestly year over year, reflecting growth in the rate base. Morningstar DBRS expects earnings to continue to see a modest increase in 2025 assuming approval of the 2025-26 GRA.

FINANCIAL OUTLOOK
Newfoundland Power's financial risk assessment has remained stable, with all key credit metrics supportive of the current credit rating. Morningstar DBRS expects the Company to continue managing any free cash flow deficits from the capital expenditures program and dividends in a prudent manner in order to maintain leverage in line with the regulatory capital structure of 55% debt. Morningstar DBRS notes that Newfoundland Power's cash flows are expected to be weaker in the short term because the PUB deferred some cost items to a future period. Morningstar DBRS expects the cash flow-to-debt metric to return to historical levels once the PUB approves the Company clearing the balance in its RSA.

CREDIT RATING RATIONALE
Newfoundland Power's ratings are supported by the supportive regulatory environment and its solid financial profile. This is partly offset by the weak economic outlook and limited population growth in the Province and its reliance on one major power supplier.

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

(B) Weighting of FRA Factors
In the analysis of Newfoundland Power, 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 Newfoundland Power, 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 15, 2024), https://dbrs.morningstar.com/research/431186 and
-- 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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