DBRS Comments on TransAlta’s New Renewables Company

DBRS notes that TransAlta Corporation (TAC or the Company; rated BBB) announced on June 26, 2013, that it plans to create a sponsored, separately traded renewables subsidiary, TransAlta Renewables Inc. (OpCo), with a select number of its renewable assets (the Transaction). As part of the Transaction, Canadian Hydro Developers, Inc. (CHD; rated BBB) will also be transferred from TAC to OpCo and its portfolio of assets will be restructured to align with OpCo’s operating strategy. DBRS does not anticipate that the Transaction will have a material impact on the credit ratings of TAC or CHD in the foreseeable future, largely due to the strong level of integration between TAC and OpCo.

OpCo’s assets include approximately 1,007 megawatts (MW) of wind assets and 105 MW of hydro assets, which account for approximately 12% of TAC’s net capacity. TAC will be the sponsor and operator of OpCo and initially own 80% to 85% of OpCo’s equity interest. In the long term, the Company intends to continually own greater than 50% of OpCo’s equity interest.

OpCo’s credit quality is expected to be similar to that of TAC, reflecting strong integration between OpCo and TAC, OpCo’s fully contracted status, TAC’s sponsorship, and a reasonable financial risk profile. All of OpCo’s assets are expected to be fully contracted, reducing cash flow volatility. Currently, approximately 64% of OpCo’s net capacity has purchase power agreements (PPA) in place with investment-grade third parties and the remaining 36% is expected to have a PPA with TAC. OpCo’s debt is estimated to be in the $580 million range, including approximately $374 million of debt at CHD and $200 million of intercompany debt to TAC. The Transaction is expected to close in August 2013.

DBRS analysis will focus on the (1) short-term and (2) long-term implications of the Transaction.

(1) Short-Term Implications
FINANCIAL RISK PROFILE – NEUTRAL
Initially, the Transaction is expected have a minimal impact on TAC’s financial risk profile as TAC intends to pay down debt with the proceeds from the initial public offering (IPO; estimated to be $200 million to $250 million for the sale of 15% to 20% of OpCo’s equity interest). As a result, the decrease in interest expense is expected to partially offset the impact from the moderate increase in external distributions (estimated to be approximately $10 million) related to OpCo’s IPO.

BUSINESS RISK PROFILE – NEUTRAL
The creation of OpCo does not immediately result in a change in TAC’s or CHD’s business risk profiles, as a result of the strong level of integration between TAC and OpCo. This is primarily due to TAC’s majority ownership of OpCo and the power service agreement between TAC and OpCo. In addition, the restructuring of CHD’s portfolio of assets is not expected to have a material impact on CHD’s business risk profile.

(2) Long-Term Implications – MIXED
DBRS acknowledges that the new OpCo structure creates another source of equity and could serve as a lower cost of capital for future growth opportunities. However, as TAC’s ownership in OpCo decreases and OpCo’s asset portfolio grows, the integration between TAC and OpCo could weaken. In this case, DBRS will increasingly weigh on deconsolidated analysis for both TAC and CHD, which could ultimately result in a rating differential between TAC and CHD. TAC’s rating could be pressured if it significantly increases its exposure to construction and development risk of greenfield projects, as well as merchant risk, and funds new projects heavily with debt. This may not have a material impact on CHD if OpCo continues to fully hedge power production through PPAs with investment-grade counterparties and maintains reasonable financial metrics.

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

The applicable methodology is Rating Companies in the Non-Regulated Electric Generation Industry, which can be found on our website under Methodologies.