DBRS Confirms Ratings of Hydro One Inc. at A (high) and R-1 (low)

DBRS Limited (DBRS) has today confirmed the Issuer Rating and the Senior Unsecured Debentures rating of Hydro One Inc. (HOI or the Company) at A (high), and the Commercial Paper rating at R-1 (low). All trends are Stable. The rating confirmations reflect the Company’s relatively low risk business profile supported by a transparent regulatory framework, a strong franchise in electric power transmission and distribution services and a reasonable financial profile sustained by predictable earnings and cash flow. The Stable trend assumes that the quality of the regulatory regime will continue to remain supportive, allowing the Company to earn a fair rate of return while recovering costs on a timely basis. DBRS rates HOI as a stand-alone entity and does not assume any credit support from its owner, Hydro One Limited (HOL), which is approximately 70% owned by the Province of Ontario (the Province; rated AA (low) with a Stable trend by DBRS).

The Company’s transmission business (approximately 61% of 2016 EBIT) owns and operates approximately 98% of the transmission network in the Province while the distribution business (approximately 39% of 2016 EBIT) serves nearly 26% of the Province’s customers. HOI’s transmission (for 2015–2016) and distribution (for 2015–2017) businesses currently operate under a cost-of-service (COS) model. HOI filed a COS transmission rate application for 2017–2018 in May 2016 with the Ontario Energy Board (OEB) and an approval is expected in Q2 2017. HOI’s next transmission rate application for the period 2019–2023 is expected to be filed under a Custom Incentive Rate-Setting (CIR) approach. The Company also filed its CIR distribution rate application with the OEB in March 2017 for the 2018–2022 term requesting a 2018 revenue requirement increase of 3.5% over 2017. DBRS views the CIR model as suitable for HOI, as it provides greater clarity with respect to the Company’s ability to recover high and variable capital expenditure (capex) requirements. However, utilities are required to operate under the CIR framework for a longer period (five years), which modestly increases forecasting risk and regulatory lag.

HOI’s capex program is expected to be approximately $9.75 billion in the 2017–2021 term (transmission: $6.2 billion; distribution: $3.55 billion) largely to replace and upgrade aging infrastructure. HOI’s dividend payout ratio is expected to remain high in order to meet HOL’s dividend objectives to pay out approximately 70% to 80% of its consolidated net income. DBRS expects HOI’s credit metrics to be pressured in the medium term because of the high capex (averaging approximately, $2.0 billion, annually) and dividends resulting in free cash flow deficits, which are likely to be funded with incremental debt. However, the incremental cash flows are expected to ease the pressure on metrics as projects are placed in service and added to rate base. HOI’s ratings could be impacted should its cash flow-to-debt ratio weaken below 13% and its DBRS adjusted debt-to-capital exceeds 60% on a sustained basis. DBRS expects any potential acquisitions of unregulated businesses to be carried out at the HOL level. DBRS also notes that acquisitions by HOI of regulated utility assets in less supportive regulatory regimes or acquisition of regulated assets with some exposure to unregulated operations could weaken the business profile of the Company and have an impact on ratings.

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 principal methodologies are Rating Companies in the Regulated Electric, Natural Gas and Water Utilities Industry and DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers, which can be found on www.dbrs.com under Methodologies.