TEXT-S&P cuts TransAlta Corp ratings to 'BBB-'

Wed Aug 1, 2012 1:45pm EDT

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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