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Rating Action:

Moody's Affirms TransAlta's ratings; outlook remains negative

06 Mar 2015

Approximately $1.6 billion of debt securities affected

Toronto, March 06, 2015 -- Moody's Investors service, has affirmed TransAlta Corporation's senior unsecured ratings at Baa3. The outlook remains negative.

RATINGS RATIONALE

"The negative outlook reflects the ongoing weaknesses in key financial metrics," said analyst Gavin MacFarlane. "While management has outlined a strategy to continue to delever the company in 2015, there is execution risk associated with management's dropdown strategy and in delivering strong operating results required to achieve the financial metrics consistent with the rating."

Moody's expects that TransAlta will use the proceeds from dropdowns to TransAlta Renewables, Inc. (RNW) primarily to reduce debt at TransAlta Corp, a credit positive, and to fund its $650 million growth capital program. In our opinion, it is highly unlikely that any proceeds from the dropdowns will be used to finance share buybacks or increase dividends. Nevertheless, TransAlta's business risk profile may be weakened given that 30% of the cash flow generated by those assets will no longer be available to service debt at the parent and that the assets likely to be sold to RNW will be contracted assets which will reduce the overall level of cash flow predictability of the remaining assets at TransAlta. Initially, RNW may fully fund the dropdowns with equity; however, it is likely only a matter of time before RNW issues debt in conjunction with the dropdowns which will lead to some incremental structural subordination to creditors at TransAlta Corporation. The effectiveness of using dropdown proceeds for debt reduction at the parent is largely dependent upon the EBITDA multiples achieved in the transactions and the amount of debt financing utilized by RNW.

Distributions to non-controlling interests (NCI) at RNW will grow over the next few years as TransAlta executes its dropdown strategy, reducing the level of consolidated cash flow available to the parent and thus diluting the analytical value of using a consolidated approach. A proportionately consolidated approach to financial analysis in our opinion is more meaningful than looking at fully consolidated financials given the expected increasing role of RNW and non-consolidated interests at TransAlta. Currently, the low levels of external debt at RNW (70% ownership) and TA Cogen (50.01% ownership -- no debt) combined with including 100% of their cash flows leads to consolidated financial metrics that paint a stronger picture of credit quality at TransAlta than warranted by fundamental cash flows.

In-service assets with an EBITDA of about $400 million have been identified as part of a drop down inventory, compared to consolidated 2014 EBITDA of more than $1 billion. While TransAlta has indicated that they expect to maintain their existing RNW ownership stake at 70%, further drop-downs will reduce TransAlta's effective ownership of these assets. Moving to a proportionately consolidated approach clearly highlights the analytical impact of changes in asset ownership and ownership interests in RNW. The timing of additional debt issuances at RNW remains uncertain; however, this approach also clarifies the impact of additional debt from a financial metrics perspective. A proportionate consolidation approach will capture the cash flow leakage to TransAlta Corp, measured by subtracting distributions paid to subsidiaries' non-controlling interests from TransAlta's consolidated CFO. These distributions represent cash paid to minority shareholders that is not available to service debt issued by TransAlta Corp. Under a proportional consolidation view, we will look at TransAlta's debt at consolidated entities based on ownership. Using 2014 FYE result this approach leads to proportionately consolidated CFO pre-W/C to debt of 14% at TransAlta Corp. Our analysis includes the expectation that RNW will distribute the vast majority of its distributable cash flow.

Based on the company's expected business risk profile and peer analysis, a proportionately consolidated financial metric approach at a minimum threshold of 17% CFO Pre-W/C to debt has been identified as a key financial metric associated with maintaining a Baa3 rating, replacing the previously cited consolidated level of 19%. At present, the financial metrics remain below the levels associated with the current rating. The company has provided 2015 consolidated FFO guidance in a range of $720-770 million and in order to achieve our 17% CFO Pre-W/C threshold the company must achieve the top of the range and substantially delever. In addition to using dropdowns to delever, we expect management to continue to use some combination of preferred shares with some equity characteristics, a DRIP program, assets sales, partnerships or equity issuance. Given the challenges associated with achieving these metrics, the odds of a negative rating action are greater than 1 in 3.

The principal methodology used in this rating was Unregulated Utilities and Power Companies published in October 2014. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

Outlook

While we could typically look to resolve our outlook within the next 6 months, provided credit quality continues to improve we may delay the resolution of the outlook by up to an additional 6 months.

What could change the Rating -- Up

Given ongoing forecasted weakness in financial metrics, an upgrade in the near term is highly unlikely. Sustained proportionately consolidated CFO Pre-W/C/Debt in the mid 20% range could lead to an upgrade. The outlook could be stabilized if the company achieves proportionately consolidated CFO Pre-W/C/Debt of about 17% on a sustainable basis.

What Could Change the Rating -- Down

Failure to achieve and sustain proportionately consolidated CFO Pre-W/C/Debt of 17% will likely lead to a downgrade. Any material operating issues leading to underperformance or a change in the business risk profile of the company; for example, a material change in its contractual profile could also lead to a downgrade.

Affirmations:

Preferred Stock Shelf, Affirmed (P)Ba2

Senior Unsecured Shelf, Affirmed (P)Baa3

Senior Unsecured Regular Bond/Debenture, Affirmed Baa3

Outlook Actions:

Outlook, Remains Negative

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain 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 certain 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 certain 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.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The rating has been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

Moody's has not provided advisory services but may have provided Ancillary or Other Permissible Service(s) to the rated entity, its related third parties and/or the party that requested the rating within the past two years (including during the most recently ended fiscal year). Please see the special report "Ancillary or other permissible services provided to entities rated by MIS's credit rating agency in Canada" on the ratings disclosure page www.moodys.com/disclosures on our website for further information.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

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.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Gavin MacFarlane
Vice President - Senior Analyst
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 Affirms TransAlta's ratings; outlook remains negative
No Related Data.
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