DBRS Morningstar Confirms Liberty Utilities Finance GP1 at BBB (high), Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and the rating of the Senior Unsecured Notes (Senior Notes) of Liberty Utilities Finance GP1 (LUF or the Issuer) at BBB (high) with Stable trends. All the debt issued by LUF is unconditionally guaranteed by its related party, Liberty Utilities Co. (LUCO or the Guarantor). The Issuer and the Guarantor are wholly owned by Algonquin Power & Utilities Corp. (rated BBB with a Stable trend by DBRS Morningstar). The proceeds from the Senior Notes are used to invest in the senior unsecured notes (related-party Notes) issued by LUCO. The Senior Notes and the related-party Notes contain the same terms and conditions. The ratings of LUF are based on the Guarantee and LUCO’s business and financial risk profile.

The rating confirmations reflect (1) LUCO’s improved business risk profile as result of growing and more diverse regulated asset base across United States; (2) LUCO’s solid financial metrics for the last 12 months to September 30, 2019 (LTM 2019); and (3) reasonable rate case outcomes in 2019. The ratings incorporate the structural subordination of the Senior Notes to the debt at Empire District Electric Company (Empire), which currently accounts for approximately 30% of the LUCO’s consolidated debt. However, the structural subordination is mitigated by a diverse source of cash flow from 13 jurisdictions and unlevered cash flow (over 50% of consolidated cash flow) from its subsidiaries with minimal or no debt. LUCO’s business risk profile is supported by reasonable allowed return on equity at 9.7% (weighted average), reduced cost-recovery lags, significant jurisdictional diversification, no commodity price risk, and modest volume risk.

LUCO’s credit ratios for LTM 2019 were modestly weaker than 2018 (reflecting lower cash flow largely due to weather impact and U.S. tax reform) but remained solidly supportive of the current ratings and were as follows: (1) cash flow-to-debt ratio and EBIT-interest coverage were strong at 14.6% and 3.49 times, respectively; and (2) the debt-to-capital ratio, excluding goodwill but including the parent debt guarantee, remained the mid-60% range. DBRS Morningstar expects LUCO’s credit metrics to remain stable in 2020 as LUCO is expected to generate significant positive free cash flow (net of dividends) to finance its organic capital expenditure (capex) of approximately $600 million.

However, LUCO’s credit metrics may come under pressure in 2021 as a result of (1) a proposed acquisition of 600 megawatt of wind power (regulated assets) by Empire ($1.1 billion, estimate, expected to close in 2021) and (2) an agreement to acquire New York American Water—a regulated water utility ($600 million, estimate, expected to close in 2021/2022) (the Proposed Acquisitions). LUCO is planning to finance its 2021 capex and the Proposed Acquisitions with a mix of free cash flow, equity contribution, third-party tax equity contributions, and debt. DBRS Morningstar expects the Proposed Acquisitions to improve the size and diversification of LUCO’s operations, but the impact on LUCO’s financial profile would depend on LUCO’s financing plan, which has not been finalized at this time. DBRS Morningstar notes that LUCO has some financing flexibility to finance the Proposed Acquisitions and maintain the current ratings. However, if the Proposed Acquisitions significantly weakened LUCO’s credit metrics from the current levels on a sustained basis, a negative rating action may be taken. On the other hand, DBRS Morningstar could take a positive rating action if LUCO’s structural subordination is significantly reduced and its operational diversification is improved while its credit metrics remain stable.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodologies are Rating Companies in the Regulated Electric, Natural Gas and Water Utilities Industry; DBRS Criteria: Guarantees and Other Forms of Support; and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships, which can be found on dbrs.com under Methodologies & Criteria.

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 under Related Documents or by contacting us at info@dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other related internal documents of the rated entity or its related entities in connection with this rating action.

DBRS Morningstar 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.

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