DBRS Rates Royal Utilities Income Fund at BBB

DBRS has assigned a rating of BBB to the Unsecured Senior Debt of Royal Utilities Income Fund (RUIF or the Fund). The Fund is the 100% owner of Prairie Mines and Royalty Ltd. (the Company), the largest thermal coal producer in Canada (with 94% of the market).

The Fund’s business profile is strong as it has a stable revenue source and limited exposure to commodity prices. A substantial portion of the Fund’s revenue comes from supplying thermal coal to baseload utility customers (all rated solid investment grades) in Alberta and Saskatchewan. Its coal supply contracts are long term with either a direct pass-through of operating costs or inflation-indexed pricing for the majority of operating costs. (DBRS notes, however, that the Company is exposed to a time lag between the changes in coal prices to reflect changes in input costs on the inflation-based escalator contracts). In addition, the Fund has a substantial royalty income stream (over $37 million annually), which adds to earnings and cash flow stability.

The mines have gone through significant modernization and improvement since 2003. All mines are surface mines, which are generally more cost efficient with higher coal recovery (there are less operational risks with open pit mining than underground mining). The mines have large reserves and long mine lives with low maintenance capital needs. The Company’s mines are mine-mouth mines (i.e., the mines are located next to the power plants) and are the exclusive coal suppliers to these power plants. The proximity to the power plants eliminates most of the transportation costs, giving the Company a major cost advantage (and minimizing the risk that the utility customers would seek an alternate supply of coal and not renew existing contracts).

Support is provided by the Fund’s co-owners, each with a 41.2% stake: Sherritt International Corporation (Sherritt) and Ontario Teachers’ Pension Plan Board (Teachers). Sherritt has considerable experience in the thermal coal industry and will continue as the operator of the mines, providing significant expertise to the management of these assets. With the Fund’s IPO in June 2006, over $600 million in debt was retired, thereby lowering interest payments substantially going forward.

As a result, the Fund’s present financial profile is strong as per cent gross debt was 23.2% and cash flow-to-total debt was 0.50 times (for the twelve months ended March 31, 2007). This conservative capital structure provides RUIF with financial flexibility, which facilitates organic and acquisition-driven growth. DBRS expects the Fund’s debt-to-capital ratio to remain moderate, supported by strong cash flow relative to debt, offsetting a somewhat high payout ratio, targeted at 97% of distributable cash.

DBRS notes that the major challenges facing the Company are its lack of product and geographic diversification. The Company concentrates on just one commodity - thermal coal - and only operates in Alberta and Saskatchewan, exposing it to the economic cycles of these two regions with similar industrial characteristics, (although with very positive outlooks). DBRS expects the performance and financial profile of the Fund to remain stable, in line with the positive prospects of its operating regions over the medium term

Note:
All figures are in Canadian dollars unless otherwise noted.