Buffett’s Canada Utility Fights Alberta Rules to Skirt Downgrade

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Warren Buffett’s AltaLink LP is facing a possible debt downgrade amid Alberta regulatory decisions that have made utility bonds the worst corporate performers in Canada.

AltaLink, the transmission company purchased by Buffett’s Berkshire Hathaway Inc. energy unit for C$3.2 billion ($2.6 billion) last year, is fighting rulings by the Alberta Utilities Commission that investors, analysts and the company say reduce returns and increase the risk for losses.

“These bonds have materially underperformed comparable provincial bonds,” said David Frei, who helps manage C$19 billion of fixed income investments as senior portfolio manager at Fiera Capital Corp. in Toronto. “In light of what we identify as heightened regulatory risk and the credit-negative impact that it has on Alberta utility bonds, we prudently reduced our holdings to a significant underweight position in the past year.”

The regulator on March 23 reduced the allowed return on equity for utilities to 8.3 percent from 8.75 percent. That followed a November 2013 ruling that shareholders are accountable for gains or losses on assets removed from service from an unanticipated event.

The Alberta Court of Appeal is hearing the utilities’ case against the 2013 decision by the Alberta Utilities Commission next week in Calgary. AltaLink joined AltaGas Ltd., Enmax Corp., Epcor Utilities Inc. and units of Atco Ltd. and Fortis Inc. in the appeal. The commission said Alberta utilities remain healthy businesses.

Downgrade Risk

“If some of the regulatory risks that the financial community is talking about in Alberta manifest themselves, that’s going to cause a downgrade of not only AltaLink but also many utilities in Alberta,” Scott Thon, AltaLink’s chief executive officer, said in a phone interview. “That just means an increase in our debt costs, and we’re raising a lot of debt in Alberta.”

Buffett didn’t return a request for comment left with an assistant.

With a loss of 5.1 percent since March 25, Calgary-based AltaLink’s bonds are the fifth-worst performer among Canada’s largest corporate bond issuers, Bank of America Merrill Lynch data show. Atco’s CU Inc., which owns electricity and gas and pipelines businesses, is the worst performer with a 5.9 percent loss. Fortis, an electricity distributor, is the third worst performing with a 5.8 percent loss.

Wider Spreads

Investors demand an average premium of 142 basis points to hold bonds of Canadian utilities over benchmark government bonds, 16 basis points more than the average among company debt, according to Bank of America Merrill Lynch data.

The Alberta Utilities Commission is standing by its positions. The 2013 decision was an interpretation of a Supreme Court ruling that utilities disposing of assets outside the normal course of business must deliver all the profits of a sale to shareholders, without sharing with ratepayers. In the same way, utility owners should bear losses from damage to their assets in extraordinary circumstances, said Jim Law, a commission spokesman.

The March decision to lower return on equity for utilities is consistent with their improved cost of capital, as financial markets have strengthened in recent years, Law said.

“Alberta utilities are healthy,” Law said in a phone interview. “It shows in their filings to us and you can also look to the recent sale of AltaLink as a clear demonstration that the transmission assets in Alberta are highly valued.”

Capital Structure

In a rate application this week, AltaLink proposed to temporarily change its capital structure to finance more of its business from equity, as it seeks to lower leverage to avoid a downgrade, CEO Thon said. If its bonds are downgraded, debt would be pricier and costs would be passed down to ratepayers, he said. The bonds are rated A- by Standard & Poor’s and A by DBRS Ltd.

The extra yield above government debt investors demand to hold AltaLink’s C$500 million of notes due November 2023 is 90 basis points, eight basis points more than in mid-March before the decision.

The battle over returns comes as Alberta teeters on the verge of recession from a collapse of crude oil prices.

The altered capital structure AltaLink is proposing is positive for its credit score, said James Jung, senior vice president of energy and banking at DBRS Ltd. in Toronto. If the regulatory environment deteriorates further in Alberta, it could affect credit ratings of utilities, he said.

“Some of the decisions that have come out of the AUC recently have caused us to ask ourselves whether or not the regulatory environment in Alberta is as strong as it once was,” said Stephen Goltz, a credit analyst at Standard & Poor’s in Toronto. “To the extent that we don’t think the regulatory environment is as strong, it definitely could have implications on ratings.”

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