Société en commandite Gaz Métro
Cause tarifaire 2007, R-3596-2006
RESEARCH
Research Update: Gaz Metro Inc. 'A-' Ratings Affirmed,
Subsidiary Gaz Metro LP Rated 'APublication date:
Primary Credit Analyst:
Secondary Credit Analyst:
Credit Rating:
18-Apr-2006
Bhavini Patel, CFA, Toronto (1) 416-507-2558;
bhavini_patel@standardandpoors.com
Nicole Martin, Toronto (1) 416-507-2560;
nicole_martin@standardandpoors.com
A-/Stable/--
Rationale
On April 18, 2006, Standard & Poor's Ratings Services affirmed its 'A-'
long-term corporate credit rating on Gaz Metro inc. (GMi). At the same
time, Standard & Poor's affirmed its 'A' senior secured debt, and 'A-2'
global scale and 'A-1(Low)' Canadian scale CP ratings on GMi; and assigned
an 'A-' long-term corporate credit rating to Gaz Metro's majority-owned
subsidiary Gaz Metro Limited Partnership (GMLP). At the same time,
Standard & Poor's assigned a recovery rating of '1' to GMi's C$827 million
first mortgage bonds, indicating a high expectation of recovery of
principal in the event of a payment default. The outlook on GMi and GMLP
is stable.
The ratings on GMi reflect supportive regulation, the stable nature
of its gas distribution business, its strong cash flows and consistent
financial performance. The key challenges facing GMi are low market
penetration of natural gas in the Province of Quebec relative to
electricity, a heavy reliance on industrial customers, and susceptibility
to modest cash flow variability from economic slowdowns.
GMi is the general partner of and holds a 72.8% interest in its sole
asset, GMLP, a Montreal, Que.-based partnership. The partnership has
achieved a modest level of diversity and cash flow stability through its
regulated gas distribution, transportation and storage assets that
represent 95% of GMi's assets (C$2.7 billion) and cash flows. The Quebec
distribution company represents the bulk of the earnings from the
regulated businesses. Nonregulated businesses, which represent about 5% of
consolidated EBITDA and assets, include urban heating and cooling
services, a minority interest in a local fiber-optic network, and two
small water infrastructure management companies. Total debt outstanding at
Dec. 31, 2005 was C$2.182 billion.
Enhancing GMLP's strong business position is supportive regulation.
GMi's Quebec distribution assets are allowed to earn a return on capital
for the delivery of natural gas and have no commodity exposure, as gas
commodity costs are completely passed on to customers in a timely manner.
In addition, most operating costs are also passed on to customers and the
company benefits from a performance-based regulatory arrangement. Unique
to the regulatory environment in Quebec (for gas distribution assets)
relative to other Canadian regulatory regimes, GMLP is allowed to
generate, and has earned, incentive earnings above the regulated base ROE.
For the 2006 fiscal year, the allowed ROE is 9.33% composed of a base
return of 8.95% and an incentive of 0.38% as a share of productivity
gains. In addition, returns earned above 9.33% are shared 25% and 75%,
respectively, for GMLP and customers. Incentive returns have been able to
offset decreases in base rate of returns that are linked to lower
government bond yields. GMLP can also recoup exogenous costs through
regulated deferral accounts associated with increased gas prices;
increased interest, storage, and transportation costs; and weather-induced
declines in gas demand and cash flows.
GMi's operations are largely focused on low-risk natural gas
distribution and transmission, with little commodity risk exposure. The
company's core operations are relatively stable and predictable, given the
Original : 2006.05.31
limited operating risk associated with these assets. Nevertheless, GMLP's
recent expansion of its mission statement to place additional focus on
SCGM - 8, Document 11
(3 pages en liasse)
other energy-related sectors, although presently marginal, could have
greater business risk than that associated with its current operations and
might influence GMi's consolidated risk profile over time. Accompanying
any new large-scale expansion projects are potential regulatory,
construction, commodity, and financing risks. Of particular interest for
GMi's future business risk profile are any risks surrounding projects such
as the proposed Rabaska liquefied natural gas terminal and GMi's proposed
partnership to develop wind generation assets in Quebec.
GMLP's average financial risk profile largely reflects the highly
leveraged balance sheet (of the Quebec gas distribution assets) of about
60% compared with global peers and low rates of return. Rates are set
using regulated assumptions and a deemed capital structure. As a result of
a marginally more favorable ROE that GMLP is allowed to earn relative to
other Canadian-based distribution companies, cash flow protection measures
have been, and will continue to be relatively stronger than those of its
peers. In the next two years, key credit metrics are expected to remain
stable; GMLP is expected to have projected adjusted funds from operations
(FFO) interest coverage of more than 4.0x and FFO to average total debt of
about 22%. Although strong cash flow generation is expected to be more
than sufficient to meet all capital expenditures within the forecast
period, GMLP's distribution policy of distributing between 95% and 100% of
its earnings to unitholders constrains the company's financial flexibility.
Although the utility's competitive position within Quebec for natural
gas distribution is strong (distributing 97% of natural gas consumed),
market penetration of natural gas in Quebec is low, about one-half the
national average, as a result of highly competitive electricity rates.
Hydro-Quebec historically had provided customers with electricity at below
market prices. As a result, GMLP has a low residential penetration rate in
the energy market. Recent electricity distribution rate increases and the
expectation of additional electricity rate increases by the Regie de
l'Energie will marginally improve gas' competitiveness in the long term.
Gaz Metro's relatively higher exposure to industrial customers with
fuel-switching capability exposes GMLP to the pricing differentials
between natural gas and fuel oil prices. Furthermore, the large exposure
to industrial customers exposes GMLP to economic slowdowns. The provincial
economy is somewhat cyclical, given the large manufacturing sector, but
the cyclical nature has been diminishing over time as the service sector's
share of output has grown. The main risks to Quebec's economy remain the
economic health of the U.S. and of the other Canadian provinces, given the
importance of the trade sector to Quebec.
Liquidity
Standard & Poor's assesses GMi's liquidity to be adequate. Internally
generated cash flow and availability under the company's credit
facilities provide sufficient funds to support variable working
capital requirements and 2006 debt maturities. Cash flows are
sufficient to meet the company's near-term capital spending of about
C$150 million. Supporting its internal cash position, GMi also
maintains access to external financing through its various credit
facilities. The company had about C$44.7 million available on its
C$400 million CP program as of Dec. 31, 2005, and the CP program is
backed by a C$400 million term loan that matures in December 2010.
GMLP and its subsidiaries also have about C$100 million in revolving
short-term lines of credit, of which C$100 million was available at
Dec. 31, 2005. The utility's debt maturity schedule is not onerous
with C$28 million due in 2006 (on a fiscal year basis). The company
is currently in compliance with all of the financial tests and
covenants contained in its credit facilities.
The CP program is adequate, when factoring for normal seasonal
fluctuations that are consistent with building gas inventories in the
summer and fall to meet winter demand requirements.
Recovery analysis
The rating on GMi's first mortgage bonds is 'A' with a recovery
rating of '1', indicating a high expectation of full recovery of
principal (100%) in the event of a payment default. The secured debt
at GMi is rated one notch above the corporate credit rating due to
the amount of collateral securing the debt. GMi's first mortgage
bonds are secured under a trust deed that contains a hypothec on the
universality of movable property, present and future, of GMi situated
in the province of Quebec. The creditors are also covered by a first
immovable hypothec on GMLP's present and future pipelines and gas
distribution system. The first mortgage bonds comprise nine
individual debt issues with maturities ranging from 2006 to 2034.
Standard & Poor's believes that if GMi were to default, it would
continue to operate as part of a reorganized entity because of the
essential service nature of its business. The single most important
factor in determining a utility's asset value upon emergence from
bankruptcy is the revenue stream that regulators allow it to collect.
In GMi's case, there is a high correlation between the value of the
regulated rate base and the asset's book value. Therefore, absent
extenuating circumstances, Standard & Poor's will assume that the
asset's book value represents a fair value for the assets. The
recovery estimate compares the level of collateral to the potential
amount of secured debt.
Outlook
The stable outlook reflects the expectation of a steady regulatory regime
and consistent earnings. GMi's financial risk profile is expected to
remain relatively unchanged in the near term, as the company's cash flow
protection measures will be determined largely by its deemed capital
structure and regulated returns. A negative rating action is possible if
GMi's business profile weakens through a material expansion of
nonregulated businesses without a corresponding strengthening of its
financial profile. Conversely, an outlook revision to positive is unlikely
and would require significant financial improvement over a sustained
period with no increase in business risk.
Ratings List
Rating Assigned
Gaz Metro Limited Partnership
Corporate credit rating
Ratings Affirmed
Gaz Metro Inc.
Corporate credit rating
Senior secured debt
Commercial paper
Canadian scale
Global scale
A-/Stable/--
A-/Stable/-A (Recovery rating: 1)
A-1(Low)
A-2
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