DBRS Downgrades TransAlta Corporation to BBB (low) and Pfd-3 (low), Changes Trends to Stable

DBRS Limited (DBRS) has today downgraded the Issuer Rating and Unsecured Debt/Medium-Term Notes rating of TransAlta Corporation (TAC) to BBB (low) from BBB. DBRS also downgraded TAC’s Preferred Shares rating to Pfd-3 (low) from Pfd-3. The trends for all the above-mentioned ratings were changed to Stable from Negative, where they were placed on March 10, 2016.

DBRS’s rating actions follow a review of TAC’s 2016 financial results and refinancing plan for corporate debt over the medium term, the Off-Coal Agreement (OCA) with the government of Alberta and the potential structure of the Alberta whole-sale power market post-2020. The rating downgrades reflect the fact that the business risk profile of TAC will weaken following the expiry of the Alberta power purchase arrangements (PPAs). Currently, stable cash flow from coal facilities in Alberta (majority under Alberta PPAs) account for approximately 35% of total EBITDA. Post-2020, some coal plants will retire and the remaining coal plants (to be converted into gas-fired generation) and hydro plants will be subject to the whole-sale market capacity auction structure, which remains uncertain at this time. There is also uncertainty with respect to the plan to convert most coal plants to gas-fired generation. DBRS will evaluate additional information regarding the market structure and coal-to-gas conversions as it becomes available and will assess the credit quality of TAC on an ongoing basis.

The trends were changed to Stable, reflecting the following: (1) Under the OCA, TAC will receive $37.4 million per year from 2017 to 2030, which will increase cash flow to TAC. However, TAC intends to monetize the OCA payments in the next 12 to 18 months. The amount from the OCA monetization is expected to be used to partially refinance the debt maturing in 2018 (approximately $959 million). DBRS notes that as part of its refinancing plan, TAC intends to raise funds at the project level. The funds from these issues will be used to finance the remaining South Hedland project capital expenditures (capex) and for upcoming maturities at Canadian Hydro Developers, Inc. (rated BBB with a Stable trend by DBRS; indirectly majority owned by TAC through TransAlta Renewables Inc.). Although TAC’s strategy of issuing debt at the project level helps to support deconsolidated metrics, it also increases the structural subordination of the debt issued by TAC. (2) The South Hedland project in Australia is on time and on budget and is expected to be commissioned by mid-2017. This project will contribute approximately $80 million in EBITDA per year. The financing of the remaining work at the project is manageable; as at the end of 2016, TAC has funded approximately $336 million, with approximately $240 million to be financed. (3) Relatively stable cash flow is expected from the contracted arrangements and Alberta PPAs between now and 2020. (4) Lower growth capex over the medium term (compared with the 2013 to 2015 period) should help to generate positive net free cash flow and support TAC’s financial flexibility.

DBRS recognizes that TAC’s 2016 financial results were solid and its current consolidated and deconsolidated metrics are supportive of the current ratings. DBRS does not expect any further material shift in TAC’s 2017 financial metrics, which benefit from the recently announced dividend cut, lower capex levels and the commission of South Hedland by mid-2017.

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

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 to the right under Related Research or by contacting us at info@dbrs.com.

The methodologies are Rating Companies in the Independent Power Producer Industry (June 2016), DBRS Criteria: Rating Corporate Holding Companies and Their Subsidiaries (December 2016) and DBRS Criteria: Preferred Share and Hybrid Security Criteria for Coporate Issuers (December 2016), which can be found on dbrs.com under Methodologies.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.