DBRS Morningstar Upgrades Fortis Inc. to A (low) and Pfd-2 (low), Changes Trends to Stable

DBRS Limited (DBRS Morningstar) upgraded Fortis Inc.’s (Fortis) Issuer Rating and Unsecured Debentures rating to A (low) from BBB (high) and Fortis’ Preferred Shares rating to Pfd-2 (low) from Pfd-3 (high). DBRS Morningstar also changed all trends to Stable from Positive. On May 4, 2020, DBRS Morningstar changed the trends on Fortis’ ratings to Positive following a significant reduction in nonconsolidated debt and an improvement in liquidity as a result of the sale of a 51% interest in the Waneta Hydroelectric Expansion (the Waneta Expansion) and a $1.2 billion common equity issuance in December 2019. After the sale of the Waneta Expansion, approximately 99% of Fortis’ consolidated EBITDA has been from regulated utilities, with the remaining 1% from long-term contracted generation assets in Belize and British Columbia.

The rating upgrades reflect (1) Fortis’ strong nonconsolidated and modified-consolidated credit metrics, solid liquidity, and stable business risk profile in 2020; and (2) DBRS Morningstar’s expectation that Fortis will continue to maintain its strong credit profile in 2021 and over the medium term. Fortis has demonstrated financial resiliency to cope with the ongoing Coronavirus Disease (COVID-19) pandemic. The current ratings take into account Fortis’ structural subordination and mitigation factors such as the diversification of regulatory jurisdictions and the size, stability, and sustainability of cash flow, as well as potential risks associated with regulatory lags, operational disruptions, and capital project executions at its regulated utilities.

DBRS Morningstar recognizes that the coronavirus pandemic did not have a material impact on Fortis’ 2020 financial performance, operations, and major capital projects. Most of Fortis’ assets are essential services and are important to maintain continual economic activities and social and health safety. The pandemic has not significantly affected Fortis’ volume distributions to date. Approximately 83% of revenues are protected by either regulatory mechanisms such as deferral accounts and decoupling or under residential sales, which increased during the pandemic. Capital spending of $4.2 billion in 2020 was consistent with Fortis’ plan for the year and was reasonably financed at its regulated utilities.

From a regulatory perspective, there have not been material changes since DBRS Morningstar’s last rating review in May 2020. Regulated utilities in British Columbia are in their second year of the Multiple-Year Rate Plan (2020–24), which is similar to the 2013–19 Performance Base Regulation. Alberta’s regulated operations benefitted from a regulatory decision in which Alberta Utilities Commission (AUC) reversed its previous decision with respect to the 2018 Independent System Operator Tariff Application. The AUC decision resulted in the utility retaining approximately $400 million of unamortized customer contributions in the rate base. Regulated operations in Newfoundland, New York, and Arizona are under cost of service and have not experienced any material changes in their respective regulatory frameworks. ITC Holdings (ITC), a transmission company that Fortis acquired in 2016, continues to benefit from timely cost recovery, good return on its investments, and stable cash flow with a return on equity (ROE) increasing to 10.77% (including incentive adders) in 2020 compared with the previous all-in ROE of 10.63%.

With respect to Fortis’ financial risk profile, there has been significant improvement in Fortis’ nonconsolidated metrics over the previous years while its modified-consolidated metrics have remained strong and stable. Fortis’ stable modified-consolidated metrics reflect the fact that all Fortis’ regulated utilities tend to maintain their capital structure in line with the regulatory capital structure or deemed equity and that the financing of their capital expenditures (capex) has been reasonable to maintain their credit metrics. The improvement of nonconsolidated metrics reflects a significant reduction in corporate debt. Following the sale of Fortis' 51% interest in the Waneta Expansion for approximately $1.0 billion and the issuance of approximately $1.2 billion in common equity, Fortis’ corporate debt decreased to approximately $3.6 billion at the end of 2020 from $5.4 billion in 2018 (approximately $6.0 billion following the ITC acquisition in 2016). In the meantime, cash flows to Fortis from its subsidiaries have significantly increased as the consolidated rate base grows. As a result, Fortis’ nonconsolidated metrics (as calculated by DBRS Morningstar) strengthened in 2019 and further improved in 2020 as follows: nonconsolidated debt-to-capital decreased to around 18% in 2020 from 26.5% in 2018 (31.7% in 2016), and cash flow-to-nonconsolidated debt increased to over 19% from 10.9% in 2018 (7.0% in 2016). DBRS Morningstar expects Fortis’ leverage level to remain stable over the medium term as there are currently no material financing requirements at the corporate level. Fortis expects to benefit from incremental cash flow at its subsidiaries as a result of a substantial capex program over the next five years.

Fortis expects its growth over the next few years to be mostly organic. Capex for the 2021–25 period increased modestly to $19.6 billion from $18.8 billion for the 2020–24 period. Most capex will be spent on regulated assets. As a result, Fortis’ regulated rate base, approximately $30.5 billion at mid-year 2020, is expected to grow to approximately $40.3 billion in 2025. This will further strengthen Fortis’ business risk profile as its operations will get larger and more diversified. Fortis plans to fund most of its capex program at its regulated utility level. The required funds will mainly be financed with subsidiaries’ internally generated cash flow (net of dividends to Fortis), debt issued at the subsidiaries, and a corporate dividend reinvestment program (which is common equity). DBRS Morningstar considers the financing plan to be reasonable and believes that it should not have a material impact on Fortis’ credit metrics (both nonconsolidated and modified-consolidated) in the near to medium term.

Given the rating upgrades, DBRS Morningstar believes that another positive rating action will not be likely in the medium term. DBRS Morningstar, however, would take a negative rating action if (1) Fortis’ business risk profile deteriorates significantly as a result of a weakening of the credit quality of its major subsidiaries or as a result of material acquisitions, which is unlikely based on Fortis’s current expansion plan; (2) its modified-consolidated metrics fall below the “A” rating range for a sustained period; or (3) Fortis’ nonconsolidated metrics materially weaken from the current level, especially if its nonconsolidated debt-to-capital increases substantially to around the 30% range on a long-term basis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodologies are Rating Companies in the Regulated Electric, Natural Gas, and Water Utilities Industry (October 27, 2020; https://www.dbrsmorningstar.com/research/368939), DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 2, 2020; https://www.dbrsmorningstar.com/research/369165), and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2, 2020; https://www.dbrsmorningstar.com/research/369167), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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