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Related Issuers
Rating Action:

Moody's downgrades TransAlta's senior debt rating to Baa3, outlook stable

Global Credit Research - 31 Jul 2012

Approximately $1.6 billion of debt securities affected

Toronto, July 31, 2012 -- Moody's Investors Service has downgraded TransAlta Corporation's (TransAlta) senior unsecured long term rating to Baa3 from Baa2, its senior unsecured shelf to (P)Baa3 from (P)Baa2 and its preferred shelf to (P)Ba2 from (P)Ba1. The outlook is stable. This rating action concludes the review for downgrade initiated by Moody's on 19 April, 2012.

RATINGS RATIONALE

This action is being taken following the company's announcement last week that preliminary Q2 operating results indicate a comparable loss in the $18-28 million range confirming Moody's view that a previously improving trend had stalled and the company's financial metrics are more consistent with a Baa3 senior unsecured rating. TransAlta's ratings were placed under review following our analysis of the 31 December, 2011 financial statements and consideration of the potential impact that the Sundance 1 & 2 arbitration decision could have on TransAlta's financial metrics. Moody's advised that the previously improving trend in TransAlta's financial profile appeared to have flattened out short of expectations and at a level that was inconsistent with TransAlta's Baa2 rating.

The heavily coal-fired generator must also manage more stringent environmental and regulatory requirements and energy markets that are being affected by abundant, low cost natural gas. Although the Sundance arbitration decision and the 11-year power contract with Puget Sound Energy for part of Centralia's output, both announced this past week, clarified two significant outstanding issues facing the company, neither outcome was sufficient to mitigate the downward pressure on the company's rating. That said, our focus has shifted to the company's financial performance over the intermediate term, as well as the company's longer term transition plans for addressing the eventual end-of-life of its coal-fired fleet under pending Canadian regulations.

Despite a 13% improvement in EBITDA for 2011 that largely reflected a $102 million contribution from TransAlta's energy trading operations, improvement in TransAlta's financial metrics had been modest. CFO pre-WC interest coverage at 4.3x (4.2x in 2010) and CFO pre-WC to Debt of 17.9% (17.0% in 2010) did not meet our expectation of interest coverage in the high 4x range and CFO pre-WC to Debt closer to 25% for it to maintain a Baa2 rating. For 2012, Q1 results showed both metrics unchanged, providing further evidence that the improving trend had stalled and the preliminary indication for Q2 does not change that view. While some of the loss for Q2 is attributable to higher scheduled maintenance during the quarter, TransAlta's energy trading reportedly produced a loss of $10 million in gross margin for the quarter, which is a $47 million swing from the comparable quarter in 2011 and highlights the earnings volatility from this segment of the business.

The Sundance arbitration decision, while negative from a credit perspective, would seem to agree with the company's view that damage to the boilers was not attributable to its operations or maintenance. The decision to accept force majeure, but to decline the company's case for economic destruction, will require a restart of the units and result in a net cost to TransAlta of approximately $50 million plus the cost of repairing and restarting the facilities that TransAlta estimates at $190 million. The total cost at $240 million, was unexpected in our Baa2 rating.

The Centralia contract with Puget runs through to end of life for the facility and in conjunction with the company's hedging will utilize 35% of available capacity through 2020, which provides some certainty to a minimum cash flow, although not of a magnitude to materially improve financial metrics.

In both cases the outcome will result in non-cash write downs of the assets aggregating $465 million which, coupled with the comparable loss for the quarter and the compensation payable to TransCanada under the Sundance PPA, is expected to produce a net loss for the quarter of $790-$810 million.

We note that TransAlta continues to have good liquidity. The company has advised that committed credit facilities were increased by $360 million to $2.4 billion in June and that there is approximately $800 million in current undrawn availability.

Additionally, in early 2012 TransAlta enhanced its dividend reinvestment program with the expectation that this would significantly increase new capital raised under the program and be a positive factor influencing the company's financial metrics. They have reported that the program has 70% participation and will contribute approximately $185 million p.a. of additional common equity, effectively dropping the dividend payout ratio from approximately 70% to 20-25% of anticipated cash flow in 2012.

OUTLOOK

With the ratings downgrade the outlook has stabilized, however, the company still faces the relatively weak market conditions that are expected to continue over the near term and the uncertainty with pending federal emissions regulation over the medium term that is expected to impact coal generation facilities. Moody's will be looking to see more definition to the company's future financial performance and longer-term transition as its coal generation runs off, as well as clarity on TransAlta's capital plan to finance the expected significant investment that will be required.

WHAT COULD CHANGE THE RATING UP/DOWN

Given the latest rating action, an upgrade over the near term is highly unlikely. Improved operating performance attributable to energy trading would not, in and of itself, provide the necessary stable earnings base to support an upgrade.

Although energy markets are not expected to improve materially over the near term, a failure to achieve FFO/Debt and FFO/Interest metrics close to 21% and 4.0x, or a prolonged delay with the restart of Sundance 1 and 2, could create downward rating pressure.

At the same time, clarification of the Sundance and Centralia uncertainties during the quarter mitigates some of the negative factors that had placed downward pressure on the ratings. While historically less than a 10% contributor of EBITDA, volatility in energy trading remains a factor that could negatively influence ratings in the short term if the amplitude of the swings were to increase significantly and energy trading became a much larger portion of operating results. Moody's attaches a relatively low probably to either occurring.

The principal methodology used in this rating was Unregulated Utilities and Power Companies published in August 2009. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

TransAlta is a wholesale power generation and energy marketing company headquartered in Calgary and with operations in western Canada (57%), eastern Canada (15%), north-western USA (24%) and Australia (4%). Producing approximately 8,400MW across 75 facilities, TransAlta's generation capacity is predominantly coal (52%) and gas (21%) fueled, with renewable sources aggregating about 26% of generation capacity.

REGULATORY DISCLOSURES

The Global Scale Credit Ratings on this press release that are issued by one of Moody's affiliates outside the EU are endorsed by Moody's Investors Service Ltd., One Canada Square, Canary Wharf, London E 14 5FA, UK, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that has issued a particular Credit Rating is available on www.moodys.com.

For ratings issued on a program, series or category/class of debt, this announcement provides relevant regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides relevant regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides relevant regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Information sources used to prepare the rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

Moody's considers the quality of information available on the rated entity, obligation or credit satisfactory for the purposes of issuing a rating.

Moody's adopts all necessary measures so that the information it uses in assigning a rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see the ratings disclosure page on www.moodys.com for general disclosure on potential conflicts of interests.

Please see the ratings disclosure page on www.moodys.com for information on (A) MCO's major shareholders (above 5%) and for (B) further information regarding certain affiliations that may exist between directors of MCO and rated entities as well as (C) the names of entities that hold ratings from MIS that have also publicly reported to the SEC an ownership interest in MCO of more than 5%. A member of the board of directors of this rated entity may also be a member of the board of directors of a shareholder of Moody's Corporation; however, Moody's has not independently verified this matter.

Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

Please see ratings tab on the issuer/entity page on www.moodys.com for the last rating action and the rating history.

The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

David Brandt
VP - Senior Credit Officer
Infrastructure Finance Group
Moody's Canada Inc.
70 York Street
Suite 1400
Toronto, ON M5J 1S9
Canada
(416) 214-1635

William L. Hess
MD - Utilities
Infrastructure Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Canada Inc.
70 York Street
Suite 1400
Toronto, ON M5J 1S9
Canada
(416) 214-1635

Moody's downgrades TransAlta's senior debt rating to Baa3, outlook stable
No Related Data.

 

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