NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB-' Issuer Default Ratings (IDR) for TransAlta Corporation (TransAlta). The Rating Outlook is Stable. A full list of ratings follows at the end of this release.
The 'BBB-' IDR reflects TransAlta's stable cash flow profile at least through 2020. A highly contracted power generation portfolio, improving credit metrics with expected debt pay down and the addition of mainly equity funded contracted cash flows, and management's commitment to lower leverage overtime to maintain an investment grade rating profile are main drivers of the assigned IDR. The assigned ratings also reflect Fitch's positive view of TransAlta's post-contracted cash flow profile in Alberta (beyond 2020), which is supported by a dynamic wholesale electricity market, robust load growth improving capacity factors for existing generating resources, and a favorable market position of TransAlta's assets in Alberta wholesale market.
KEY RATING DRIVERS
Hedged Profile in Transition: TransAlta's generation portfolio is highly contracted at present (~80%) and will remain so through 2018, thus providing a high degree of visibility to cash flows. The hedge profile will materially change beyond 2018 as the long-term power purchase agreements (PPAs) for its Alberta based coal-fired fleet start rolling-off. Currently, the Alberta assets provide about 40% of TransAlta's consolidated EBITDA.
Fitch expects the expiration of PPAs at the Alberta coal fleet by 2020 to materially increase the commodity sensitivity at TransAlta, thus, inducing greater volatility in cash flow generation. Fitch expects 50% of TransAlta's EBITDA to be generated by long-term contracted assets post 2020 while the rest is generated by assets under short duration contracts and/or open merchant sales. Fitch recognizes that the current market construct in Alberta does not allow TransAlta to hedge its resources on a long-term basis given that the buyers in the wholesale electricity market are primarily commercial and industrial users that prefer short-term contracts.
On the positive side, Fitch expects considerable improvement in TransAlta's cash flows post the expiry of the PPAs. The weighted average PPA prices are currently below market. Fitch expects wholesale electricity prices in Alberta to trend at approximately $50 - $55/MWH in 2020 and beyond.
Constructive Outlook for Alberta Wholesale Electricity Market: Alberta's wholesale market follows an economic dispatch model favoring low-cost generators and is a real-time energy market with a single price for the entire market. Even though Alberta's wholesale electricity market is the smallest wholesale electricity market in North America (between 14,000 - 15,000 MWs), it offers a robust load growth outlook through 2030. Strong electricity demand that can outpace the annual capacity additions, lack of transmission rights, and high barriers to investment in inter-market ties are positive for the outlook for electricity prices in Alberta. Fitch has assumed that these features in Alberta's electricity market will continue, at least, through 2030.
Conservative Approach to New Investments: Fitch views TransAlta's growth strategy favorably, which has so far focused on investing in long-term contracted assets, including currently scheduled new investment in Australia. Fitch has assumed $600 million in growth related investments through 2018. These investments are supportive of an investment grade credit profile and it is Fitch's expectation that by 2020 TransAlta earns at least 50% of its consolidated EBITDA from assets under long-term contracts.
Deleveraging is Critical: Fitch acknowledges the steps that management has taken to rein in leverage such as dividend cut along with equity issuance through its dividend reinvestment plan (DRIP) in 2014. However, further deleveraging is needed to appropriately align the capital structure to a higher business risk profile post 2020. In this regard, management's stated goal of $300 - 500 million of senior debt reduction and predominantly equity funded new growth investments over 2015 - 2017 will be key. Fitch has assumed total capex, including growth capex, of about $2 billion through 2018 that will be funded through issuance of preferred capital, internally generated funds, and proceeds from the transfer of contracted assets to its renewable subsidiary, TransAlta Renewables, Inc. (TRI, not rated by Fitch).
LTM adjusted debt/EBITDAR was 4.9x as of Sept. 30, 2014. Fitch expects the ratio to improve to 3.5x by 2018 driven by modest EBITDA growth and decline in total adjusted debt. Beyond 2018, Fitch expects TransAlta to maintain adjusted debt/EBITDAR between 3.0x and 3.25x and FFO/Debt of approximately 28% in order to maintain investment grade ratings. While Fitch expects consolidated EBITDA to improve due to contribution from the announced growth projects, incremental debt reduction could be needed over 2018 - 2020 to achieve this target if power prices in Alberta fall below Fitch's expectations. Fitch believes this level of incremental debt reduction is achievable.
In maintaining the assigned ratings, Fitch will continuously monitor TransAlta's cash flow profile, level of sales to industrial and commercial customers in Alberta, and its strategy to drop-down contracted assets in TRI without affecting TransAlta's cash flow profile and asset quality.
Drop down of Assets to TRI: TRI is a publically listed, yield driven and growth oriented vehicle. A drop down of assets into TRI provides the company with an alternate source of capital and management has highlighted $700 - 1,000 million of proceeds from such drop downs over the 2015-17 time period.
Fitch acknowledges the enhanced financial flexibility that TRI provides TransAlta but at the same time a steady pace of transfer of TransAlta's portfolio of contracted assets compromises the quality of assets left behind at TransAlta. Fitch expects TransAlta to use a portion of the proceeds from the transfer of contracted assets for its debt reduction. In its public comments, management has reinforced its commitment to credit ratings, and Fitch expects TransAlta to meet the targeted credit metrics on a pro forma basis. Fitch will continue to monitor management's acquisition and financial strategy and rising conflict of interest between TransAlta and TRI. A predominantly shareholder focused use of proceeds from transfer of assets will have negative implications for TransAlta's credit.
Adequate Liquidity: As of Sept. 30, 2014, TransAlta had about $1.6 billion in total liquidity, including $245 million in cash on hand. Available liquidity is sufficient to meet funding needs over next 18 - 24 months. $1.8 billion of credit facilities will expire in 2017. 2015 debt maturities of $712 million are manageable.
Ratings Upgrade Unlikely: Given the uncertainty associated with the changing business profile and management's stated deleveraging targets, a positive rating action is unlikely over the next 12-24 months. Adjusted debt to EBIDTAR would need to sustain at 2.5x before Fitch would consider an upgrade.
Negative Rating Action: Future developments that either individually or combined could lead to negative rating actions include:
--Adjusted debt/EBITDAR greater than 3.25x on a sustainable basis;
Change in growth investments strategy such that the proportion of EBITDA from long-term contracted assets falls to below 50% beyond 2020; and
--A change in TransAlta's strategy to support its renewable business that will transfer contracted assets to TRI without commensurate decrease in holding company debt and expose TransAlta's cash flows to market volatility.
Fitch Rates TransAlta Corporation as follows:
--Long-term IDR 'BBB-';
--Senior unsecured debt 'BBB-'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014).