TEXT-S&P cuts TransAlta Corp ratings to 'BBB-'
Overview -- We are lowering our long-term corporate credit and senior unsecured debt ratings on TransAlta Corp. to 'BBB-' from 'BBB'. -- We are also lowering our global scale preferred stock rating on the company to 'BB' from 'BB+', and our Canada scale rating to 'P-3' from 'P-3(High)'. -- The cash flow related to a recently announced contract at TransAlta's Centralia facility largely falls outside of our rating horizon; as a result, the positive impacts of an improved business risk profile and associated cash flows have a small impact on our analysis. -- As we said in our research update from July 23, 2012, the recent arbitration decision on Sundance Units 1 and 2 increased the probability of a downgrade because it increases the business risk related to an additional 2.5 gigawatts of capacity sold under similar power purchase agreements and it led to additional deterioration in the company's financial risk profile. -- The stable outlook reflects our view that adjusted funds from operations-to-debt will remain in the 15%-20% range, below the 20% threshold we associated with the previous ratings. Rating Action On Aug. 1, 2012, Standard & Poor's Ratings Services lowered its long-term corporate credit and senior unsecured debt ratings on Calgary, Alta.-based power generation company TransAlta Corp. to 'BBB-' from 'BBB'. At the same time, Standard & Poor's lowered its global scale preferred stock rating on the company to 'BB' from 'BB+', and its Canada scale rating to 'P-3' from 'P-3(High)'. The outlook is stable. The downgrade reflects our belief that TransAlta will not improve and maintain its adjusted funds from operations (AFFO)-to-debt to levels consistent with the previous ratings or improve its business risk profile in the near term. Rationale The cash flows associated with the long-term contract that TransAlta has signed at its Centralia facility reduce volume and price risk on the units. However, the contract falls largely outside our rating horizon, so it has a negligible immediate credit impact. The contract does not start to generate cash flows until December 2014 and is contracted for 180 megawatts (MW) of capacity ramping up in the following two years to reach 380 MW out of a total capacity of 1,340 MW (28% of the total) in December 2016. The contract is with Puget Sound Energy Inc (BBB/Stable/A-2), a combined electric and gas utility business focused in the Puget Sound region of Washington State, which is subject to regulatory review by the Washington Utilities and Transportation Commission. We expect AFFO-to-debt to remain in the 15%-20% range. While we expect management to undertake some actions to improve the TransAlta's financial risk profile in the near term, we do not believe it will be sufficient for the previous ratings. Our analysis also incorporates low AFFO-to-debt in 2012 as a result of the Sundance 1 and 2 arbitration decision and net outflows of C$240million before the units return to service in the fall of 2013. The ratings on TransAlta reflect Standard & Poor's opinion of the company's strong business risk profile and significant financial risk profile. In our view, the business risk profile reflects a predominance of long-term power purchase arrangements (PPAs) and a relatively diversified electricity generation portfolio. We believe that offsetting these credit strengths are high leverage; the potential for year-to-year volatility in cash flow due to revenue exposure to volume and price risk; asset concentration at Centralia, TransAlta's largest merchant asset; and the company's involvement in high-risk energy trading activities. An underlying level of profitability and cash flow stability comes from long-term power contracts (with a minimum of five years to maturity). TransAlta owns and often operates both large and small generation facilities in North America and Australia. For the 2012-2015 forecast period, more than two-thirds of its capacity is contracted primarily through legislated Alberta PPAs or other long-term contracts, with the balance coming from merchant capacity that the company hedges over a rolling four-year period. At June 30, 2012, TransAlta had about C$5.2 billion in adjusted debt. Key assumptions underlying the ratings including the following: -- Ongoing weak power pricing in the Pacific Northwest and downward pressure on the forward curve in Alberta following the expected return to service of Sundance 1 and 2 in fall 2013; -- Ongoing low gas prices that we expect will continue to negatively affect pricing in both markets; -- No additional meaningful contracts at Centralia within the rating horizon; and -- Our expectation that any securities issued with equity content and used to pay down debt will be insufficient to materially affect the ratings. Liquidity We believe TransAlta has adequate liquidity. Our assessment incorporates the following expectations and assumptions: -- We expect the company's liquidity sources over uses to exceed 1.2x during the next year, and we expect sources to exceed uses even in the event that EBITDA declines 15%. -- TransAlta will continue to have solid relationships with its banks and a generally satisfactory standing in credit markets. -- Liquidity sources primarily consist of AFFO of about C$800 million for 2012 (excluding the arbitration decision's impact) and undrawn committed facilities of about C$800 million as of July 23, 2012. -- Uses of liquidity include expected sustaining capital spending of about C$400 million, debt maturities of about C$300 million, net penalty payments of C$150 million, and dividends of more than C$300 million (excluding the impact of dividend reinvestment programs). We believe the company will continue to have sufficient headroom under its existing covenants. Outlook The stable outlook reflects our expectation of AFFO-to-debt remaining in the 15%-20% range and a relatively stable business risk profile. We could raise the ratings if TransAlta improves its business risk profile or if we expect the company to achieve and maintain AFFO-to-debt of more than 20%. Conversely, while we don't expect it, a material debt-financed acquisition or capital building program, costly regulatory or environmental initiatives, or a sustained deterioration in plant operating performance leading to AFFO-to-debt falling below 15% could result in a downgrade. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Lowered TransAlta Corp. To From Corporate credit rating BBB-/Stable/-- BBB/Negative/-- Senior unsecured debt BBB- BBB Preferred stock Global scale BB BB+ Canada scale P-3 P-3(High)
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