Morningstar DBRS Confirms TransAlta Corporation at BBB (low) and Pfd-3 (low) With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating and Unsecured Debt/Medium-Term Notes credit rating of TransAlta Corporation (TAC or the Company) at BBB (low) and the credit rating on the Company's Preferred Shares at Pfd-3 (low). The trends on all ratings are Stable.

KEY CREDIT RATING CONSIDERATIONS
On November 14, 2024, TAC announced that it had entered into an amending agreement to the original share purchase agreement (November 2023) with an affiliate of Energy Capital Partners, the parent of Heartland Generation Ltd. and Alberta Power (2000) Ltd. (collectively, Heartland). TAC has also entered into a consent agreement with the Commissioner of Competition pursuant to which TransAlta has agreed to divest Heartland's Poplar Hill and Rainbow Lake assets following closing of the Transaction. The revised transaction price of $542 million will be further reduced by approximately $80 million following the closing of the Transaction to reflect the economic benefit of the Heartland business arising since October 31, 2023, which is payable to TAC, consistent with the terms of the original share purchase agreement. The transaction is expected to close in December 2024. We maintain our view that the impact of the acquisition on TAC's business risk assessment will be neutral, with improvements to the Company's diversification and size offset by the modestly weaker contract profile and the structural subordination from the assumption of the $232 million project debt. The company is expected to finance this transaction with available cash on hand and possibly some draws on its credit facility.

The Province of Alberta's (Alberta or the Province; rated AA with a Stable trend) merchant spot electricity prices decreased to $55 per megawatt hour (MWh) in Q3 2024, compared with $152 MWh in Q3 2023. As a result, TAC's Alberta hydroelectric facilities, which represent more than 90% of the Province's hydro generation plants, witnessed a decline in revenue compared to previous year, but remains highly profitable to the company due to low or minimal fuel costs. The Alberta hydroelectric assets generated approximately 27% of the Company's consolidated adjusted EBITDA in the nine months ended September 30, 2024. TAC continues to maintain its financial metrics, and we expect the Company to generate modest free cash flow surplus despite decline in merchant spot prices.

TAC's contract profile remains strong, with more than 90% of the Company's consolidated free EBITDA (after maintenance capital expenditures) coming from either long-term contracts with a weighted-average (WA) life of approximately 11 years or from hydro-generation plants in Alberta. We believe TAC currently benefits from the Province's energy-only market and the Company's hydro-generation assets. However, TAC's exposure to the Province's power market remains a concern because most power-generation assets in Alberta are without long-term power purchase agreements.

We note the credit ratings incorporate the structural subordination of TAC's debt to the nonrecourse debt at its projects and subsidiaries. We believe the structural subordination is significantly mitigated because most of TAC's modified cash flow comes from assets with no or minimal debt. However, we note that, if the project-level debt increases significantly, structural subordination could become a greater concern, which could result in a negative credit rating action.

CREDIT RATING DRIVERS
Morningstar DBRS is unlikely to take a positive credit rating action in the near to medium term unless there is a significant improvement in the leverage profile. However, Morningstar DBRS could take a negative credit rating action if (1) the current contractual profile deteriorates materially, or (2) the consolidated cash flow-to-debt ratio falls below 15% on a sustained basis.

EARNINGS OUTLOOK
Morningstar DBRS expects TAC's 2024 consolidated EBITDA to decline compared to previous two years as a result of substantial decline in merchant power pricing. We also expect TAC's realized power pricing to remain subdued over the medium term because of increased supply from renewable energy sources partially offset by favourable hedging position of the company. TAC also announced mothballing of its 400-megawatt (MW) Sundance 6 facility beginning April 2025. We expect the impact of this move on the Company's earning profile to be limited (less than 5% of EBITDA) because of additional generation output from its newer installed capacities. The company has the flexibility to re-activate this facility if power pricing improves substantially.

FINANCIAL OUTLOOK
As discussed in the earnings section, because of lower realized power pricing, Morningstar DBRS expects the Company's key credit metrics to deteriorate slightly but remain relatively stable. TAC is expected to continue to mitigate its cash flow volatility arising from merchant exposure in Alberta by actively entering into short-term financial hedges.

CREDIT RATING RATIONALE
The rating confirmations reflect TAC's (1) reasonable contractual profile, (2) low fuel risk and cost competitiveness, and (3) operational expertise. These strengths are partially offset by (1) merchant generation risk, (2) structural subordination of cash flows, and (3) expansion risk. The Stable trends reflect Morningstar DBRS' view that (1) the exposure to merchant risk in Alberta for 2025 is well hedged and (2) TAC's business risk and 2025 consolidated credit metrics are likely to continue supporting the current credit ratings.

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

(B) Weighting of FRA Factors
In the analysis of TAC, 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 TAC, 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 (November 25, 2024), https://dbrs.morningstar.com/research/443429

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

Morningstar DBRS Criteria: Approach to ESG 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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