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Can Canadian Regulated Utilities Sustain 2019 Improvements Amid COVID-19 And An Oil Price Slump?


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Can Canadian Regulated Utilities Sustain 2019 Improvements Amid COVID-19 And An Oil Price Slump?

In 2019 many of the Canadian IOUs showed a marked improvement in their credit quality over the previous year. For example, four of the six major Canadian IOUs strengthened their financial measures, with higher funds from operation (FFO) to debt over the 2018 levels. In addition, some IOUs attained a higher mix of low-risk regulated cash flows as part of consolidated business profiles. However, we now expect the combined impact of COVID-19 and the oil price crash could stall this momentum for Canadian IOUs and result in weaker credit metrics for 2020 compared to 2019 (see "North American Regulated Utilities Face Additional Risks Amid Coronavirus Outbreak," March 19, 2020, and "COVID-19: The Outlook For North American Regulated Utilities Turns Negative," April 2, 2020). In S&P Global Ratings' assessment, 2020 could be a tough year for some Canadian IOUs. We've examined the various challenges utilities such as Algonquin Power & Utilities Corp. (APUC), AltaGas Ltd. (AltaGas), ATCO Ltd. (ATCO), Emera Inc. (Emera), Fortis Inc. (Fortis), and Hydro One Ltd. (Hydro One) could face in 2020 and what it means for their credit quality.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession(see our macroeconomic and credit updates here: As the situation evolves, we will update our assumptions and estimates accordingly

Table 1

Select Canadian Investor-Owned Utilities
Algonquin Power & Utilities Corp. AltaGas Ltd. ATCO Ltd. Emera Inc. Fortis Inc. Hydro One Ltd.
Business risk profile Strong Strong Excellent Excellent Excellent Excellent
Financial risk profile Significant Aggressive Significant Aggressive Significant Significant
Issuer credit rating BBB BBB- A- BBB A- A-
Outlook Stable Stable Stable Stable Negative Stable
FFO to debt range 13%-15% 10%-11% 14%-15% 11%-11.5% 10.5%-11% 10.5%-11%
Downside threshold 14% 10.0% 15.0% 10.0% 10.5% 11%
Upside threshold 21% 15.0% 20.0% 13.0% 10.5% 16%
Most recent rating action Affirmed Outlook revised to stable Affirmed Ratings lowered Affirmed Outlook revised to stable
FFO--Funds from operations. Source: S&P Global Ratings and company data.

Chart 1


Table 2

Canadian Investor-Owned Utilities--Peer Comparison
Industry Sector: Combo
Algonquin Power & Utilities Corp. AltaGas Ltd. ATCO Ltd. Emera Inc. Fortis Inc. Hydro One Ltd.
Ratings as of May 13, 2020 BBB/Stable/-- BBB-/Stable/-- A-/Stable/-- BBB/Stable/-- A-/Negative/-- A-/Stable/--
--Fiscal year ended Dec. 31, 2019--
(Mil. Mix curr.)
$ C$ C$ C$ C$ C$
Revenue 1,624.9 5,495.0 4,706.0 6,111.0 8,783.0 6,480.0
EBITDA 799.2 1,213.9 1,983.0 2,434.3 3,884.0 2,170.0
Funds from operations (FFO) 624.0 739.9 1,359.5 1,795.1 2,864.1 1,634.9
Interest expense 180.6 419.8 547.5 753.3 1,124.9 553.1
Cash interest paid 160.6 406.8 529.5 746.3 1,056.9 514.1
Cash flow from operations 622.1 548.3 977.5 1,585.1 2,644.1 1,555.9
Capital expenditure 579.8 1,320.0 1,186.0 2,511.6 3,726.5 1,580.0
Free operating cash flow (FOCF) 42.3 (771.7) (208.5) (926.6) (1,082.4) (24.1)
Discretionary cash flow (DCF) (231.6) (1,122.6) (659) (1,379.7) (1,682.9) (603.1)
Cash and short-term investments 62.5 57.1 1,061.0 222.0 370.0 30.0
Debt 3,884.7 8,040.3 9,735.5 16,356.3 25,233.7 15,332.4
Equity 4,963.6 6,730.3 7,123.0 8,878.5 19,301.5 9,451.0
Adjusted ratios
EBITDA margin (%) 49.2 22.1 42.1 39.8 44.2 33.5
Return on capital (%) 6.1 4.8 8.3 6.2 5.8 5.2
EBITDA interest coverage (x) 4.4 2.9 3.6 3.2 3.5 3.9
FFO cash interest coverage (x) 4.9 2.8 3.6 3.4 3.7 4.2
Debt/EBITDA (x) 4.9 6.6 4.9 6.7 6.5 7.1
FFO/debt (%) 16.1 9.2 14.0 11.0 11.4 10.7
Cash flow from operations/debt (%) 16.0 6.8 10.0 9.7 10.5 10.1
FOCF/debt (%) 1.1 (9.6) (2.1) (5.7) (4.3) (0.2)
DCF/debt (%) (6.0) (14.0) (6.8) (8.4) (6.7) (3.9)
Source: S&P Global Ratings and company data.

Chart 2


We've looked at the impact of the pandemic on FFO to debt assuming potential declines to EBITDA (see chart 2). Although most companies showed improvements in 2019, they have minimal cushion in their credit metrics heading into 2020. For many of the Canadian IOUs, a 4%-6% decline in EBITDA alone would result in funds from operations (FFO) to debt below their downside triggers.

Key Challenges In 2020 For Selected Canadian IOUs

Algonquin Power & Utilities Co. (BBB/Stable/--)

In 2019, APUC focused on the execution of its regulated growth strategy that included the planned acquisitions of Bermuda Electric Light Co. (BELCO) for about $365 million and New York Water Services Inc. (NYWS) for about $608 million, both expected to close in 2020. APUC also acquired gas utilities Enbridge Gas New Brunswick Ltd. Partnership for about C$331 million and Enbridge St. Lawrence Gas Co. Inc. for about C$70 million. The series of regulated utilities acquisitions results in only a modest improvement in APUC's business risk profile because its higher-risk nonregulated power operations still contributes about 30% of APUC's consolidated cash flow. APUC's 2019 FFO to debt was 16.1%, above our downside threshold of 14%, in part because it used a balanced mix of equity and hybrids to fund its growth strategy.

Key challenges in 2020 for APUC
  • Execution of planned equity issuances to fund its planned acquisitions.
  • Potential weaker cash flows due to higher payments in arrears and bad debt expense despite the availability of decoupling.
  • Potential for construction project delays, affecting ability to qualify for greater production tax credits (PTCs).

In 2020, COVID-19 could derail the execution of APUC's planned equity issuance to close on the acquisitions of BELCO and NYWS, considering equity market volatility in recent months. In addition, the company's 2020 cash flow could weaken because of additional expense related to COVID-19. This is a concern despite the availability of decoupling for some of APUC's regulated businesses. Furthermore, COVID-19 could delay APUC's completion of its major construction projects such that it doesn't qualify for the PTCs. In 2020, we expect APUC's FFO to debt to be about 13%-14%, assuming a short-term impact from the pandemic, before improving to about 15% in 2021.

AltaGas Ltd. (BBB-/Stable/--)

For infrastructure holding company AltaGas, 2019 was a transitional year. After the acquisition of WGL Holdings Inc. in 2018, AltaGas began execution of its de-leveraging plans that included divestiture of noncore assets of about C$2.2 billion in 2019, which brought total asset sales to about C$6.0 billion over the past 24 months. The company used the proceeds for debt reduction and capital expenditures, improving the consolidated financial measures at AltaGas, with 2019 FFO to debt at 9.2% compared to that of 2.4% in 2018.

Key challenges in 2020 for AltaGas
  • Executing the divestiture of noncore assets while maintaining its de-leveraging plan.
  • Higher COVID-19 costs, which could offset improvements in 2019 financial measures.
  • Some commodity risk exposure in 2021 for its midstream operations.

In 2020, we expect the infrastructure holding company to continue executing its de-leveraging plan with divestiture of its noncore assets. AltaGas completed the sale of its remaining shares of AltaGas Canada Inc. in March 2020, which raised proceeds of about C$369 million. However, the current economic and operating environment may complicate the execution of AltaGas' ongoing divestiture plan. In addition, COVID-19 is likely to result in decreased gas consumption, payment in arrears from customers, and an increase in bad debt and other pandemic-related expenses at the utility level. We expect the impact to be partially mitigated by the seasonality of gas consumption in North America. In addition, some regulatory support exists at the utility level through the establishment of deferral accounts to track pandemic-related expenses, but regulatory lag could weaken cash flows until full cost recovery begins. AltaGas' midstream operation is highly contracted and hedged for 2020. While most of the 2021 midstream cash flow continues to be under contract, the effectiveness of the company's hedging program for 2021 remains uncertain, which could affect AltaGas' midstream margins for the year. Overall, we expect AltaGas to achieve FFO to debt of about 10.0%-10.5% in 2020.

ATCO Ltd. (A-/Stable/--)

ATCO's credit quality improved somewhat in 2019. This was in part due to its subsidiary Canadian Utilities Ltd.'s (CUL) divestiture of nonutility assets including Alberta PowerLine (APL), an nonregulated transmission line, and the entire Canadian fossil fuel-based power generation portfolio assets. As a result, ATCO's financial measures improved in 2019 over 2018; however, FFO to debt for 2019 was 14.1%, which suggests minimal cushion at the current ratings level.

Key challenges in 2020 for ATCO
  • COVID-19 and the oil price slump could weaken regulated and nonutility cash flows.
  • Minimal cushion in current ratings level.

Despite ATCO's strong liquidity position, the company is not immune to COVID-19 and the oil price shocks. ATCO's electric and gas utility operations serve some of the oil sand regions in Alberta. As such, if historic low oil prices persist, oil companies could be forced to permanently shut down production resulting in sustained loss to load and revenue. In addition, in response to COVID-19, the Alberta government announced a 90-day utility bill payment deferral program from March 18, 2020, to June 19, 2020, and Bill 14–Utility Payment Deferral Program Act, which came into force on May 12, 2020. Bill 14 provides a framework for utilities and energy retailers to receive government loans to cover short-payments related to the program. The legislation also supports the recovery of the loan through rates from customers over a 12-month period when the program expires. The program should limit the cash flow impact on Alberta utilities. Nonetheless ATCO is exposed to the risk of load and revenue declines if the pandemic persists. Furthermore, the global economic recession is likely to affect ATCO's nonutility operations, including the structure and logistic business as customers are likely to delay capital investments. Overall, 2020 could be a pivotal year for ATCO considering minimal cushion in the company's current ratings level.

Emera Inc. (BBB/Stable/--)

We recently lowered our issuer credit rating (ICR) on Emera to 'BBB', reflecting weaker consolidated financial measures due to large capital spending and lag on the recovery. (See "Emera Inc. And TECO Downgraded On Weak Financials, Outlook Stable; Subsidiaries Ratings Affirmed," March 24, 2020.)

Key challenges in 2020 for Emera
  • Weaker cash flows from the regulated sector due to higher COVID-19 related expenses and reduced revenues.
  • Managing regulatory risks associated with the recovery of COVID-19 expenses.
  • Executing on its capital spending programs on time and budget.

After the recent downgrade, we expect the company's financial measures to be comfortably within the financial risk profile category. Nonetheless, similar to other utilities, the main challenge for Emera in 2020 would be to manage through the COVID-19 fallout. We also note that Emera has some exposure in the Caribbean region (about 5% of Emera's consolidated operations), which is heavily dependent on a tourism economy that has been severely affected by the pandemic. An offsetting factor to these risks is the company's recent sale of Emera Maine, which gives the company an additional source of liquidity. Overall, given the recent downgrade of Emera, we expect there is sufficient cushion in the company's financial measures for the current rating to absorb any temporary setbacks from COVID-19. In 2020, we forecast Emera's FFO to debt at about 10.5%-11.0%.

Fortis Inc. (A-/Negative/--)

In 2019, Fortis put most of its focus on its deleveraging plan, which subsequently improved financial measures. Specifically, the company divested noncore asset Waneta for about C$1.0 billion, and issued about C$1.2 billion of common equity. The company used both mostly for debt repayment and capital funding. As a result, Fortis' financial measures showed improvement in 2019 with FFO to debt at 11.3% compared to that of 9.6% in 2018.

Key challenges in 2020 for Fortis
  • COVID-19 and lower oil prices could reduce regulated cash flow with reduced revenue and higher expenses, offsetting improvements in 2019 financial measures.
  • Managing regulatory risks associated with the recovery of COVID-19 related expenses.
  • Executing on capital programs while maintaining credit quality.

The main challenge for Fortis is the potential risks of a persistent COVID-19 pandemic, low oil prices, and a global economic recession that could weaken the company's ability to sustain the financial cushion that it has built over the past year, which our current negative outlook reflects. In addition, Fortis has exposure in the Caribbean region (about 5% of Fortis' consolidated cash flow), where tourism is a material contributor to the local economy and has experienced steep declines because of the pandemic. Despite the availability of regulatory mechanisms in place, including deferral accounts, decoupling, and legislation backing cash flow recovery, regulatory lag will likely weaken the company's short-term cash flow. Moreover, Fortis has operations in Alberta through its operating subsidiary, FortisAlberta, where oil production is an important contributor to the local economy. Persistent low oil prices could pressure margins. To mitigate the impact from COVID-19 and the oil price slump, we expect Fortis to manage its capital spending and to work with regulators and governments to recover the potential cash flow shortfall. Overall we expect Fortis' financial measures to weaken slightly in 2020 with FFO to debt of about 10.5%.

Hydro One Ltd. (A-/Stable/--)

In 2019, Hydro One announced a new business strategy that focuses on improving and expanding its regulated utility footprint in Ontario, and excludes any active merger and acquisition activity outside of Ontario. We believe this new strategy is lower risk and will help the company improve its business risk profile over time compared to its previous strategy, which focused on riskier growth opportunities outside of Ontario.

Key challenges in 2020 for Hydro One
  • Manage regulatory risks tied to COVID-19. The settlement framework in Ontario could temporarily pressure liquidity and result in an increase to short-term debt for all utilities in Ontario, including Hydro One, if the pandemic persists.
  • Persistent low discount rate and underperformance in pension plan assets could affect pension and post-retirement benefits (PPRB) obligation adjustments.

In 2020, similar to other utilities, COVID-19 will likely result in decreased load consumption and increased payment in arrears, bad debt, and other related expenses for utilities across Ontario, including Hydro One. Although the Ontario Energy Board (OEB), regulator for Ontario, has set up deferral accounts for utilities, including Hydro One's transmission and distribution operations, to track incremental costs and lost revenues related to the pandemic for later recovery, the timing for recovery remains uncertain, and could result in weaker cash flow in the short-term. Furthermore, under the current settlement framework in Ontario, local distribution companies (LDCs), including Hydro One's distribution operations, are generally responsible for collecting payments from customers and remitting the transmission and commodity portion of the payment to the Ontario Independent Electricity Systems Operator (IESO). In the event of any missed or partial payments by customers the LDC is still required to settle with the IESO. This means that an excessive instance of payment deferrals or bad debt expense could deplete utilities' liquidity if the current pandemic persists beyond our current base-case expectation. Nonetheless, we do not see this as an immediate issue for Hydro One because it has large committed credit facilities and transmission revenue to offset the potential liquidity constraint.

The COVID-19 pandemic and oil price crash could also indirectly affect Hydro One's PPRB obligations in 2020. Specifically, unlike peers, Hydro One has a large pension obligation adjustment of about C$2.1 billion, an increase of about C$650 million compared to 2018. Hence, any underperformance of plan assets or a sustained period of low discount rates could lead to higher PPRB debt obligations, pressuring the utility's credit metrics. Overall, we expect Hydro One to maintain FFO to debt at about 10.5%-11% in 2020, assuming the coronavirus pandemic is contained.

Can The Major Canadian IOUs Maintain Recent Improvements To Credit Quality Amid Both A Pandemic And An Oil Price Slump?

Our forward view on credit quality for select Canadian IOUs suggests minimal cushion for some utilities despite improvements to credit quality attained in 2019. For APUC, AltaGas, ATCO, Emera, Fortis, and Hydro One, the ultimate impact to credit quality will depend on several factors. These include the pace of the economic recovery, the adequacy of levers the utilities use to mitigate weaker financial measures, and the strength of the regulatory measures put in place to address the negative cash flow effects of COVID-19 and the oil price slump.

This report does not constitute a rating action.

Primary Credit Analyst:Andrew Ng, Toronto + 1 (416) 507 2545;
Secondary Contacts:Mayur Deval, Toronto (1) 416-507-3271;
Obioma Ugboaja, New York + 1 (212) 438 7406;

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