DBRS Morningstar Confirms TransAlta Corporation at BBB (low) and Pfd-3 (low) with Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Unsecured Debt/Medium-Term Notes rating of TransAlta Corporation (TAC or the Company) at BBB (low) and TAC’s Preferred Shares rating at Pfd-3 (low). All trends are Stable.

DBRS Morningstar’s rating confirmations reflect the following factors: (1) more than 90% of consolidated free EBITDA (after maintenance capital expenditures (capex)) is generated either from long-term contracts with weighted-average life of more than 10 years or from strong cash flows from hydro generation plants in the Province of Alberta (Alberta or the Province; rated AA (low) with a Stable trend by DBRS Morningstar); (2) TAC has completed its coal-to-gas conversion plan within budget; and (3) TAC’s better-than-expected financial performances in 2021 due to higher realized power prices in Alberta. TAC’s 2021 financial profile remained supportive of the current rating, with improved modified credit metrics compared with 2020. These metrics are expected to remain solid over the medium term.

The Company’s rating also incorporates structural subordination of its debt to the nonrecourse debt at its 100%-owned projects and debt at TransAlta Renewables Inc. (RNW; 60% owned by TAC). The structural subordination issue is significantly mitigated by cash flow from no or minimal debt assets, which account for approximately 70% of TAC’s modified cash flow. TAC's strategy is to expand its renewable asset base through RNW or through direct investment by TAC. As a result, cashflow contribution to TAC from RNW is expected to grow in coming years. Additionally, if the debt at RNW increases significantly to accommodate its expansion, structural subordination could become a concern and could affect TAC's ratings. However, currently the debt at RNW is modest in terms of total consolidated debt. In addition, DBRS Morningstar is of the view that although TAC currently benefits from the energy-only market in Alberta and from its hydro generation assets, TAC's exposure to the power market in Alberta remains a concern because most power generation assets in this province are without long-term power contracts.

During 2021, TAC’s hydro plants (the Hydro Assets), accounting for approximately 90% of the Province’s hydro assets, benefitted from a strong power market and low operating costs contributing to approximately 25% of the total adjusted EBITDA. In addition, the Hydro Assets also benefit from being used for system stability and reliability, which is important as Alberta’s system is experiencing an increase in wind power generation. Furthermore, hydro generation always gets dispatched because of the zero marginal cost and can consistently generate positive cash flow even in the low-power-price environment. Although TAC's Hydro Assets benefitted from substantially higher prices in Alberta during 2021, DBRS Morningstar expects EBITDA contribution from the Hydro Assets to remain significantly higher than the amount generated under contracts prior because the contract price was significantly lower.

DBRS Morningstar notes that Brookfield Renewable Partners L.P. (rated BBB (high) with a Stable trend by DBRS Morningstar) along with its institutional partners (collectively, Brookfield) invested $750 million in TAC through the purchase of Exchangeable Securities (refer to TAC’s rating report dated April 16, 2021, for details). Brookfield has the right to convert the Exchangeable Securities into an equity ownership interest in an entity to be formed that will hold the Hydro Assets. In case Brookfield exercises its right at the end of 2024, TAC’s cash flow from the Hydro Assets, accounting for approximately 25% of TAC’s consolidated cash flow in 2021, would reduce considerably and would have a negative impact on TAC’s business risk profile. The impact on TAC’s modified credit metrics will depend on TAC’s debt level at that time.

The Stable trends reflect DBRS Morningstar's view that (1) the exposure to merchant risk in Alberta for 2022 is well hedged, and (2) TAC’s business risk and 2022 credit metrics (modified consolidated) are expected to remain supportive of the current ratings.

On September 27, 2021, one of the towers at RNW's Kent Hills wind facility collapsed (Kent Hills outage). Upon, further investigation, RNW decided to replace foundation of 50 towers at the Kent Hills wind facility. This repair may result in additional capex up to $100 million and foregone revenue of up to $40 million per year. DBRS Morningstar doesn’t expect the Kent Hills outage to have material impact on TAC's financial performance during 2022 because currently RNW only contributes approximately 30% of the overall cashflow.

DBRS Morningstar does not expect to take any positive rating action in the near to medium term. However, a negative rating action could be taken if any of the following happens: (1) the sustained weakening power market in Alberta; (2) a material deterioration from the current contractual profile; (3) a significant increase in the RNW's debt and cashflow contribution to TAC's overall cashflow; and (4) the overall key modified consolidated credit metrics falling below the BBB range on a consistent basis.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodologies are Rating Companies in the Independent Power Producer Industry (May 10, 2021, https://www.dbrsmorningstar.com/research/361185) and DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (October 21, 2021, https://www.dbrsmorningstar.com/research/369165), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021, https://www.dbrsmorningstar.com/research/373262).

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@dbrsmorningstar.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 relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

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@dbrsmorningstar.com.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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