Fitch Ratings-New York-16 June 2017: Fitch Ratings has affirmed the following long-term ratings for Hydro-Quebec (HQ) (outstanding amounts as of Dec. 31. 2016):
- Long-Term Issuer Default Rating (IDR) at ‘AA-’;
- C$45.6 billion parity unsecured debentures and medium-term notes at ‘AA-’.
Fitch also assigns an ‘AA-’ rating to the $53.7 million series 0072 parity medium-term notes (MTNs), due April 19, 2019. All denominations are in Canadian dollars unless noted otherwise.
The Rating Outlook is Stable. HQ’s commercial paper rating and Short-Term IDR were recently affirmed at ‘F1+’ on June 2, 2017.
HQ’s outstanding long-term debt is an unsecured parity obligation of the utility supported by an irrevocable and unconditional payment guarantee by the Province of Quebec (‘AA-’/‘F1+’/Stable Outlook).
KEY RATING DRIVERS
PROVINCIAL RATING: HQ’s foremost rating driver is the irrevocable and unconditional payment guarantee of HQ debt provided by the Province (Long- and Short-Term IDRs of ‘AA-/ F1+’). The guarantee ranks equally in right of payment with all other unsecured obligations of Quebec Province. HQ’s debt accounts for approximately 15.7% of the Province’s total debt. LOW-COST HYDROELECTRIC SYSTEM: HQ benefits from a very low-cost hydroelectric generating system that is largely carbon-free. Its substantial reservoirs provide a distinct energy storage advantage over neighboring North American hydroelectric utilities.
STRONG FINANCIAL PERFORMANCE: HQ has a history of solid consolidated financial performance, with coverage of full obligations at 1.68x-2.21x for the past five years. Consolidated net income for fiscal 2016 was strong, at $2.86 billion, although lower than fiscal 2015 ($3.15 billion) due to winter weather closer to average and lower market prices for export sales. Operations at each of HQ’s business segments have been sound and profitable.
SOUND LIQUIDITY: HQ continues to generate and maintain solid cash flow and available reserves. Liquid resources include cash and short-term investments totaling $3.4 billion, and a US$2 billion revolving credit facility. Days cash and liquidity is ample at 448 days as of Dec. 31, 2016.
LARGE CAPITAL PLAN: For the past five years, HQ has been investing heavily in new generation and transmission. Capital expenditures for the past five years have totaled $19.3 billion through 2015, and will approximate $18 billion through 2020. HQ will continue to fund the majority of capex with cash reserves, mitigating debt issuance and maintaining equity capitalization at roughly 30%.
INCREASING BUSINESS RISK: Prospectively, HQ’s consolidated business profile could be subject to greater margin volatility as HQ increases its reliance on more variable export sales from its production division and the utility explores power-related investments outside of Quebec for added revenue growth.
RATINGS SENSITIVITIES PROVINCIAL RATING CHANGE: A change in the long-term debt rating of Quebec Province (‘AA-’/Stable Outlook) could affect the ratings of Hydro-Quebec (HQ), given the provincial payment guarantee supporting HQ’s debt.
SOUND UTILITY FUNDAMENTALS: Although unlikely at the current rating level, HQ’s rating could be revised separately from that of the Province, if Fitch determined that HQ’s utility operations, projected financial performance, and independence from the Province supported a higher rating than that provided by the guarantee.
Hydro-Quebec is a vertically integrated electric system in Canada, providing electric service to 4.2 million customers in Quebec. With installed generating capacity of 36,908 MW and over 34,000 kilometers of transmission lines, HQ is among the largest electric systems in North America. In comparison, Bonneville Power Administration, a large wholesale provider in the U.S., has about 11,000 MW in peaking capacity and more than 24,000 kilometers of transmission. HQ generates roughly 99% of its energy through low-cost hydroelectric power.
HQ is comprised of four principal operating divisions: HQ Production (power generation); HQ TransEnergie (transmission division); HQ Distribution; and HQ Innovation, equipement et services partages (designs, builds and refurbishes generation and transmission facilities). Both the HQ transmission and distribution divisions are subject to rate and regulatory oversight by the Province’s utility commission, the Regie de L’energie. The distribution system’s customer base is well diversified with residential, commercial, and large industrial classes accounting for 45%, 33%, and 20%, respectively, of 2016 distribution revenues (other sales account for the remaining 2%). HQ’s unregulated production division generates the largest proportion of HQ consolidated net income - 65.3% for FYE2016.
NEW ISSUE DETAILS
The $53.73million series 0072 senior unsecured MTNs were issued April 27, 2017. The MTNs are zero-coupon notes which were privately placed with the Hydro-Quebec Trust for Management of Nuclear Fuel Waste (HQ Trust), an entity of which Hydro-Quebec is the primary beneficiary. The MTNs are part of HQ’s larger, long-term debt program for 2016-2020, which includes the issuance of up to $20 billion in MTNs. As of Dec. 31, 2016, HQ has thus far issued C$14.2 billion and US$340 million in MTNs under this debt program.
STABLE FINANCIAL PERFORMANCE
HQ is a self-sufficient utility, supporting its debt independently of the province. HQ has a long history of stable financial performance with debt service coverage ranging from 1.97x - 2.88x for the past five years. Coverage of full obligations, which treats HQ’s substantial transfers to the Province as an operating expense, is lower but remains solid at 1.68x-2.21x - in line with the rating category median for 2016. HQ’s businesses have been able to sufficiently raise rates, meet project development on time and under budget, and increase export sales to generate net income. Consolidated funds available for debt service have remained solid for the past five years, despite relatively modest transmission and distribution system rate increases. HQ continues to utilize substantial (50%-80%) cash-funding of capital expenditures through 2016 and is projected to do the same through 2020.
Financial performance for fiscal 2014 and 2015, was particularly strong, with colder than normal winters in Quebec driving native sales higher, along with stronger than expected export sales (higher volume). HQ hit a record new high net income figure of $3.33 billion at FYE2014, and $3.15 billion at FYE2015. FY2016 net income moderated to $2.86 billion due to lower kwh sales in Quebec (as winter weather returned to average); and lower net income from export sales primarily due to lower market electricity prices.
HQ projects 2017-2020 consolidated performance similar to FY2016, with modest distribution system sales growth (0.4% per annum), continued low market electricity prices on export sales, regulated businesses’ rate increases at less than inflation, and G&T capex of $3 billion-$4 billion per year (roughly two-thirds cash-funded). Based on these assumptions, HQ’s net income should remain below the $3 billion mark, closer to the historical level of $2.5 billion-$2.8 billion through 2020. The strategic focus on potential G&T investments outside of Quebec adds a new layer of business risk, although HQ’s forecast includes a modest $100 million in net income contribution from new growth avenues in 2020. No specific external investments have been noted yet.
HQ’s days operating cash is sound, with $3.4 billion in unrestricted cash and short-term investments, or the equivalent of 242 days cash, in-line with the ‘AA-’ peer median of 222 days for 2016. Including external operating lines and an undrawn credit facility (US$2 billion), HQ’s days liquidity is a very strong 448 days. HQ’s external credit facility expires in 2022; the operating bank lines are renewed automatically each year in the absence of any notice to the contrary.
The analysis supporting HQ’s debt and IDRs includes a variation from the U.S. Public Power Rating Criteria. The variation relates to the evaluation of HQ’s credit quality using the U.S. public power criteria even though HQ is domiciled in Canada.