DBRS Morningstar Downgrades Cumulative Preferred Shares of Canadian Utilities Limited to Pfd-2; Confirms Remaining Ratings

DBRS Limited (DBRS Morningstar) downgraded the rating of the Cumulative Preferred Shares of Canadian Utilities Limited (CUL, the Holdco, or the Company) to Pfd-2 from Pfd-2 (high). DBRS Morningstar confirmed both the Issuer Rating and the Unsecured Debentures rating at “A,” and its Commercial Paper rating at R-1 (low). All trends are Stable.

The downgrade of the Cumulative Preferred Shares reflects DBRS Morningstar’s expectation that CUL could issue more debt in the future either through the long-term debt or the use of its credit facilities, such that the higher-than-standard mapping of Pfd-2 (high), which only applies in rare cases where an issuer has no or minimal debt and has no plan to issue debt in the future, is no longer appropriate. DBRS Morningstar expects CUL to maintain its financing flexibility at the Holdco level in the medium term. The standard mapping of the preferred shares is Pdf-2.

The confirmations reflect (1) the Holdco’s solid consolidated and nonconsolidated cash flow credit metrics, strong liquidity, and reasonable leverage; (2) the strong credit profile at its sizable and diversified regulated subsidiaries, particularly at CU Inc. (CUI; rated A (high) with a Stable trend by DBRS Morningstar); and (3) stable cash flow from its regulated natural gas distribution operations in Australia, ATCO Gas Australia Pty. Ltd. (AGA), and from LUMA Energy LLC (LUMA Energy). CUI, AGA, and LUMA Energy accounted for most of CUL’s consolidated cash flow in 2021 and are expected to contribute more than 90% of CUL’s cash flow in the medium terms. CUL's ratings incorporate the structural subordination of its debt to the debt issued by CUI as well as AGA. LUMA Energy has no debt.

CUI’s ratings serve as a basis for CUL ratings. In addition, DBRS Morningstar also considers structural subordination and low leverage at the Holdco level. The Holdco holds a 100% interest in CUI. DBRS Morningstar estimates CUI accounted for more than 90% of CUL’s consolidated cash flow. CUI is one of the largest and most diversified regulated utilities in Canada, with a rate base of approximately $13.3 billion as at mid-year 2021. On July 25, 2022, DBRS Morningstar confirmed the A (high) rating of CUI. Please see DBRS Morningstar’s report on CUI dated August 2, 2022.

CUL’s credit profile is further supported by stable cash flow, although not material, from AGA and LUMA Energy. AGA owns a regulated natural gas distribution business, accounting for approximately 5% of CUL's long-term EBITDA (DBRS Morningstar estimates). AGA currently operates under cost of service regulation with a return on equity of 5.02% and an equity thickness of 45% (more details below).

CUL owns a 50% interest in LUMA Energy, which operates Puerto Rico’s electricity transmission and distribution system over a term of 15 years until 2036. DBRS Morningstar considers LUMA Energy a quasi-regulated operation and is of the view that this is credit positive for CUL as the LUMA Energy operation will provide CUL with stable cash flow without additional debt at the Holdco level. In addition, the acquisition at the end of June 2021 of Pioneer Pipeline (a natural gas transmission pipeline running from Drayton Valley, Alberta, to the Wabamun area west of Edmonton) should improve regulated cash flow, as the acquisition cost, approximately $225 million, was approved to be added to the rate base.

CUL’s consolidated financial risk profile remained strong and relatively stable in the last 12 months ended June 30, 2022, reflecting a reasonable consolidated leverage. Stable cash flow is supported by a large rate base and the fact that a substantial portion of CUL’s operations, such as electricity transmission, natural gas distribution, and natural gas transmission is exposed to very limited volume risk. The volume risk at the Canadian electricity distribution operation is modest. The volume risk associated with the natural gas distribution operation in Australia is significantly mitigated by the new five-year access arrangement, effective January 2020, which includes rebasing of revenue for recovery of operating costs, approved capital expenditures, and a forecast of demand for volume.

The CUL’s consolidated liquidity was strong, with approximately $1.1 billion in cash and equivalents, and approximately $1.6 billion in available committed credit facilities as at June 30, 2022. At the Holdco level, CUL remained reasonably low (below 10%) at the end of 2021. The consolidated CUL has credit facilities totalling $2.45 billion and maturing between 2023 and 2026. As at June 30, 2022, the availability amount was $1.6 million.

DBRS Morningstar does not expect to take a positive rating action on CUL’s ratings because these are largely constrained by CUI’s ratings. However, the following factors could place pressure on CUL’s current ratings, should they occur: (1) adverse changes in regulation in Alberta that negatively affect CUI’s ratings; (2) a change in the business mix that would reduce the cash flow contribution from CUI to CUL’s overall consolidated cash flow; (3) a material increase in consolidated and/or nonconsolidated leverage; and (4) a substantial increase in nonregulated operations on a sustained basis.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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 (September 24, 2021; https://www.dbrsmorningstar.com/research/384922); DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (October 21, 2021; https://www.dbrsmorningstar.com/research/386355); and DBRS Morningstar Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (March 1, 2022; https://www.dbrsmorningstar.com/research/393065), 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 (May 17, 2022; https://www.dbrsmorningstar.com/research/396929).

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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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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