DBRS Confirms Toronto Hydro Corporation at “A,” Commercial Paper Rating at R-1 (low) with Stable Trends

DBRS Limited (DBRS) has today confirmed Toronto Hydro Corporation’s (THC or the Company) Issuer Rating and Senior Unsecured Debentures & MTNs rating at “A” and the Commercial Paper rating at R-1 (low). All trends are Stable. The ratings reflect THC’s low-risk electricity distribution business, underpinned by a transparent and supportive regulatory framework that serves an economically stable franchise area and provides relatively predictable earnings.

The Company is in the third year of a five-year Custom Incentive Rate-Setting model approved by the Ontario Energy Board, which has provided THC with funding certainty for its ongoing large capital program. DBRS expects the regulatory regime in Ontario to remain transparent and supportive, allowing the Company to recover prudently incurred costs in a timely manner and to earn an adequate return on equity (9.30% for 2015 to 2019). THC’s significant capital expenditure program, however, has continued to pressure its credit metrics. The Company’s capital program is largely non-discretionary as it is focused on meeting growing customer demand and maintaining the reliability of the distribution grid. In November 2016, THC’s board of directors decided to reduce dividend payments to its owner, the City of Toronto (the City; rated AA, Stable), to $25 million per year from approximately $60 million to $70 million per year. In December 2016, City Council approved a one-time equity contribution of $250 million to the Company in order to restore and enhance the Company’s dividend capacity. Further implementation details and conditions for this equity contribution are expected from the City in Q2 2017.

The Company’s key credit metrics as at December 2016 (cash flow-to-total debt of 15.9%; total debt to capital of 62.4%; and EBIT to interest coverage of 2.7 times) were reasonable for the current rating. Without considering the proposed equity contribution, DBRS expects credit metrics to weaken in the next two years and gradually improve thereafter. THC’s capital spending has averaged approximately $530 million annually in the past three years, resulting in a steady growth in the rate base. The Company’s rate base is expected to reach approximately $4.6 billion by 2019 (from $3.5 billion in 2016) and should result in stronger earnings. Although THC’s operating cash flow is expected to grow modestly, the significant capital program is expected to result in sizable free cash flow deficits that are likely to be funded with debt, causing leverage to remain above the regulatory capital structure (60% debt: 40% equity) in the near term. DBRS views the capital contribution by the City as a positive outcome as it is expected to immediately alleviate the pressure on credit metrics compared to the reduction in dividends. The Company’s ratings could be downgraded should THC fail to maintain cash flow-to-debt and debt-to-capital at or near 15% and 60%, respectively, in the medium term.

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

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 our website under Methodologies.

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.