Fitch Affirms TransAlta at 'BBB-'; Outlook Revised to Negative

NEW YORK--()--Fitch Ratings has affirmed the long-term Issuer Default Rating (IDR) of TransAlta Corp. at 'BBB-' and revised the Rating Outlook to Negative from Stable. The Negative Outlook reflects Fitch's view that TransAlta faces meaningful headwinds in the form of persistently low energy prices and adverse currency fluctuations as it strives to de-lever its balance sheet. The Outlook revision also reflects Fitch's concern that the pending regulation in Alberta to impose a tax on carbon and to curtail the use of coal-fired generation could hurt TransAlta's EBITDA generation over the medium- to long-term.

KEY RATING DRIVERS

Deleveraging Critical: Fitch continues to believe that additional deleveraging is required at TransAlta to align its capital structure to its post-2020 business-risk profile. Contrary to Fitch's expectations, TransAlta's consolidated debt to EBITDA increased to 5.1x in 2015, as compared to 4.4x in 2014, with the majority of this increase driven by currency translation. Fitch views TransAlta's revised financing strategy of significantly lower dividend payment as positive. This, in addition to issuance of project-level debt to reduce parent-level recourse debt will be pivotal in deleveraging.

Given the projected increase in project-level, non-recourse debt, Fitch believes it makes sense to deconsolidate TransAlta Renewables Inc., its 64%-owned publicly-traded yield-driven subsidiary. On a deconsolidated basis, TransAlta's debt-to-EBITDAR stands at approximately 4.8x, pro forma for the equity issuance and incremental asset dropdowns completed in January 2016, which remains meaningfully above Fitch's 3.5x medium-term expectations.

Environmental Regulation in Alberta: The Alberta Climate Leadership Plan, calling for mandatory retirement of all coal-fired generation by 2030, presents downside risks to TransAlta's long-term EBITDA generation profile, in Fitch's opinion. Approximately 18% of TransAlta's 3,592 MW of Alberta coal-fired capacity was expected to run till 2036-2061. Fitch will closely monitor upcoming negotiations with the Alberta government for reasonable compensation to assess the effect of the planned regulation on TransAlta's credit profile. In the medium term, however, Fitch expects the impact of the tax on carbon, starting at C$30 per tonne in 2018, to be manageable, as the cost increase can be passed through under the long-term power purchase agreements (PPAs). These PPAs are expected to still cover about 70% of TransAlta's Canadian coal fleet over 2018-2020. The tax on carbon and increased renewable power penetration should also create upward pressure on energy prices in Alberta, which would benefit the rest of TransAlta's portfolio, which comprises wind and hydro merchant assets.

Ample Financial Flexibility: TransAlta has adequate financial resources to support some volatility in its operating cash flows and the execution of its growth plan, mostly the completion of South Hedland. At year-end 2015, TransAlta had C$1.3 billion available under C$2.2 billion of committed credit facilities with maturities ranging from 2017 till 2019. Fitch views the debt maturities as manageable in 2016-2018, with clear plans to refinance most maturities early with project-level debt. Unencumbered assets with long-term contracts provide the flexibility to execute this financing strategy. The financial flexibility is resilient to downward pressure on TransAlta's credit profile.

Merchant Risk Exposure: EBITDA generation has also proven resilient to depressed wholesale energy prices in 2014-2015 and Fitch expects it to sustain around C$1 billion annually in 2016-2018, helped by highly contracted cash flows and cost-cutting initiatives. Nonetheless, Fitch sees long-term downside risk to EBITDA generation as PPAs and financial hedges roll-off. PPA prices are roughly aligned with Fitch's long-term view for wholesale electricity prices in Alberta, while hedge prices, at approximately C$45 - C$50 per MWh in Alberta for 2016-2017, exceed them modestly. In assigning the credit ratings, Fitch assumes that at least 50% of TransAlta's post-2018 EBITDA will remain from long-term contracted assets. Any lowering of Fitch's base-case sustainable EBITDA assumption would have to be met with incremental debt reduction to maintain the current ratings.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

-- Performance as currently contracted under the Alberta PPAs, including pass-through of planned tax on carbon as of January 2018;

-- Power prices in Alberta of approximately C$35/MWh in 2018 and escalating thereafter (Fitch uses Wood Mackenzie as its third-party consultant).

-- No incremental drop-downs to TransAlta Renewables, and stable ownership level.

-- Capex spending at C$450 million in 2016, C$550 million in 2017 and C$360 million in 2018.

-- Debt issuance limited to refinancing activities, and no equity issuance.

-- Common dividend of C$45 million, preferred dividend of C$46 million and TransAlta Renewables dividend payout of 80% of cash available for distribution annually.

RATING SENSITIVITIES

Positive Rating Action: The Rating Outlook could be stabilized once meaningful parent-level deleveraging is achieved and negotiations with Alberta government point toward reasonable value preservation of Canadian coal-fired generation fleet. Fitch expects a horizon of 12 to 18 months will be required to obtain the necessary visibility to consider stabilizing the Outlook.

Negative Rating Action: Future developments that either individually or combined could lead to negative rating actions include:

-- Adjusted deconsolidated debt / EBITDAR remaining above 3.5x by 2018;

-- Adverse outcome in negotiations with Alberta government resulting in substantial stranded costs and/or diminished EBITDA profile for TransAlta's coal fleet;

-- Less than 50% of EBITDA from long-term contracted assets beyond 2020;

-- Increased volatility in TransAlta's cash flows due to wholesale electricity price volatility over 2016-18.

LIQUIDITY

TransAlta has adequate liquidity, in Fitch's opinion, as modestly positive free cash flow generation over the rating horizon supplements availability under committed credit facilities. As of Dec. 31, 2015, TransAlta had a total of C$2.2 billion of committed credit facilities, of which C$1.3 billion was available. These facilities comprise a C$1.5 billion committed syndicated bank facility maturing in 2019, with the remainder comprising bilateral credit facilities. Collateral requirements for trading obligations have increased in recent quarters, but remain manageable at C$220 million at year-end 2015 with modest impact expected in case of further adverse credit rating actions. TransAlta and TransAlta Renewables have mostly independent financing facilities but TransAlta provides financial support to TransAlta Renewables through a revolving credit facility, currency hedges and PPAs.

Debt maturities are material, with US$400 million due in June 2017 presenting the first refinancing need followed by about C$950 million (C$177 million and US$520 million) due in 2018. Fitch expects TransAlta to raise C$400 million to C$600 million of project-level debt in 2016, followed by additional project-level transactions in 2017, to fund these maturities.

FULL LIST OF RATING ACTIONS

Fitch affirms the following ratings with a Negative Outlook:

TransAlta Corporation

--Long-term IDR at 'BBB-';

--Senior unsecured debt at 'BBB-'.

Date of Relevant Rating Committee: March 14, 2016

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

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Contacts

Fitch Ratings
Primary Analyst
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
Fitch Ratings, Inc.
33 Whitehall St
New York, NY 10004
or
Secondary Analyst
Maude Tremblay, CFA
Director
+1-312-368-3203
or
Committee Chairperson
Phil Smyth, CFA
Senior Director
+1-212-908-0531
or
Media Relations:
Sandro Scenga, New York, +1 212-908-0278
Email: sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
Fitch Ratings, Inc.
33 Whitehall St
New York, NY 10004
or
Secondary Analyst
Maude Tremblay, CFA
Director
+1-312-368-3203
or
Committee Chairperson
Phil Smyth, CFA
Senior Director
+1-212-908-0531
or
Media Relations:
Sandro Scenga, New York, +1 212-908-0278
Email: sandro.scenga@fitchratings.com