LDC Challenges to Accessing Capital
James Jung, CFA, FRM, CPA, CMA
Senior Vice President, Energy / Banking
416-597-7577
[email protected]
November 2014
DBRS History
• Founded in 1976, DBRS is Canada’s largest credit rating agency
• Majority ownership by global alternative asset manager The
Carlyle Group, and global private equity firm Warburg Pincus
• Head office in Toronto, with offices in the U.S. and Europe
• Approximately 150 analysts
• 13 analysts dedicated to the energy sector
# of Canadian Power Entities Rated by DBRS
60
Includes 8 Ontario power companies:
Hydro One, Toronto Hydro, PowerStream,
Enersource, Veridian, Hydro Ottawa,
IESO, Ontario Power Generation
50
40
30
20
10
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
0
LDCs No Longer Simple, Boring Business
• Growing capital investment to fund:
– Aging infrastructure
– More grid connections driven by social acceptance of renewable energy
• e.g. the Green Energy Act, FIT and Micro-FIT programs
– New technology to cope with: (a) more complex, two-way flow of electricity due
to distributed/self-generation; (b) higher levels of customer service
• M&A opportunities
– ~70 LDCs in Ontario
– Awaiting the final report from the Premier’s Advisory Council on Government
Asset (expected spring of 2015)
What Do They Have in Common?
Comparison of Electricity Prices
18.00
16.00
14.00
¢/kWh
12.00
10.00
8.00
6.00
4.00
2.00
0.00
-2.00
2010
2014
Source: Comparison of Electricity Prices in Major North American Cities by Hydro-Québec
Historical Power Price
12.0
9.0
¢/kWh
6.0
3.0
0.0
(3.0)
Average Weighted Hourly Price
Global Adjustment
Total Electricity Price
Source: IESO
Total Annual Ontario Energy Demand
160
155
150
TWh
145
140
135
130
125
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015 (F)
Source: IESO
Focusing on Efficiencies
Operating Cost
Capex Cost
Financing Cost
In the Eye of Large LDC Investors
• Despite all challenges facing LDCs with long recovery times…
• The regulatory paradigm continues to support the sector
– Capital investment will be recovered through rates with minimal
stranded cost risks
– Prudent operating costs will be recovered
– Reasonable ROE
• “Safe haven” against the backdrop of market volatility
Non-Financial Sector Spread Range
(basis points)
5-Year
10-Year
30-Year
Utilities
73 – 90
106 – 123
131 – 161
Infrastructure
92 – 108
144 – 158
163 – 186
Pipelines
96 – 134
128 – 177
162 – 218
Telecom/Media/Cable
101 – 124
148 – 174
191 – 231
Retailing/Consumer Products
110 – 130
165 – 190
212 - 249
Source: BMO Capital Markets, Jan 2015
Large LDC versus Smaller LDC
Large LDC
Smaller
LDC
Diverse
funding base
Limited
funding
alternatives
Better
treatment for
collateral
Greater
collateral
requirement
Lower
financing
charges
Higher
financing
charges
Key Obstacles for Smaller LDCs
• Reliance on bank debt
– Short-term debt creates higher refinancing risk
– Amortizing debt results in higher cash outflow and requires
frequent rebalancing of debt and equity mix
– Less cash available to fund growing capex
• Limited ability to invest in utility assets
– Unfavourable tax policy if private ownership > 10%
• i.e. departure tax, transfer tax
Funding Alternatives
• Infrastructure Ontario – Competitive pricing but restriction on
ownership requirement (100% municipal ownership)
• Shadow Banking – Private equity investors are interested in equity
stake or liquid debt rather than small debt issues
• Capital market debt – Available for $35 million plus issues with
non-amortizing terms and lighter covenants. Underwriting fees in
the range of 0.5% to 1.0%. Less flexibility (draw down vs. initial
take out)
What’s Behind the Closed Door?
Beauty Lies in the Eyes of the Beholder
• OEB versus Investors
• Prevent from forming bias opinions
• Information providers that can specialize in collecting, classifying
and analyzing data on LDCs for investors
• LDCs provide excellent benchmarks
• Key credit driving factors are similar – a common framework could
be suitable
Starting Point
• Preparing for debt issuance – the earlier the better
• Doing own homework will pay off
• Understanding what debt holders want
• Information flow focusing on debt investors
• Getting the right people together to make things happen
Who Invests in LDC bonds?
• 50 key investors in Canada
• Relatively large players with significant assets under
administration
– i.e. pension, insurance, fund managers
• Risk averse investors
• “Buy and hold” strategy but be aware of liquidity premium
• Investing in LDCs based on strong track record – no default to date
2014 Overview: Industry Remained on Steady Course
• Any change to the Provincial rating? No
• Any major change to the regulatory environment? No
• Any major shift in performance/strategy? No
• Return on equity stable at around 9%
 Stable earnings and cash flow
 Capital structures within respective regulatory guidelines
Approved Return on Equity
11.00%
10.50%
10.00%
9.50%
9.00%
8.50%
8.00%
7.50%
2005
2006
2007
Canadian Average
2008
2009
Ontario Distribution
2010
2011
2012
Ontario Transmission
2013
U.S.
2014
2015 Outlook: Stable Credit Environment
• DBRS does not anticipate any material rating changes for the
regulated utilities sector in 2015, benefiting from:
 Stable earnings and cash flow
 No material stranded cost risk
 Capital structures within respective regulatory guidelines
2016+ Outlook: Stable Credit Environment
• DBRS expects LDCs to continue to maintain capital structure in line
with regulatory parameters
• Negative rating drivers:
– Custom Incentive Regulation: This is new and the forecasting period is
longer (vs. three years under the earlier framework). Cash flow could be affected if
LDC is unable to recover large unforeseen discrepancies between forecasts and
actual capex and operating expenses in a timely manner
– Pressure on leverage as a result of large capex (potentially
exceeding the regulatory capital structure)
– Rate freeze
Contact Information
James Jung, CFA, FRM, CPA, CMA
Senior Vice President, Energy / Banking
+1 416 597 7577
[email protected]
Tom Li
Senior Financial Analyst, Energy
+1 416 597 7378
[email protected]
Henry Zhu
Senior Financial Analyst, Energy
+1 416 597 7459
[email protected]
www.dbrs.com
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