DBRS Confirms Gaz Métro inc. at A and R-1 (low), Gaz Métro Limited Partnership at STA-2 (middle)

DBRS has today confirmed the ratings of Gaz Métro inc.’s (GMi) Commercial Paper at R-1 (low) and its First Mortgage Bonds at “A,” both with Stable trends, and confirmed the stability rating of Gaz Métro Limited Partnership (GMLP) at STA-2 (middle). This removes the First Mortgage Bond and stability ratings from Under Review with Developing Implications where they were placed November 1, 2006, following the announcement of proposed changes to the tax rules for income trusts scheduled to take effect in 2011.

The confirmation of the stability rating reflects DBRS’s belief that GMLP will evaluate strategies to mitigate the impact of any new taxes, within the context of maintaining the capital structure of its regulated utility business in accordance with regulatory approved levels. However, as DBRS stated in its November 2006 press release, any reduction in future distributions due to the imposition of new taxes would be viewed as a one-time event, with subsequent analytical focus on the stability and sustainability of the revised distributions.

The confirmation of GMi’s First Mortgage Bonds is based on the continued strong business profile and credit metrics of the guarantor, GMLP, whose regulated gas distribution business remains the core component of its business operations (84% of net income). GMLP also continues to generate cash flows from operations that are sufficient to internally finance both its capital expenditures and distributions to GMi and public unitholders. DBRS expects this trend to continue over the medium term pending resolution of the tax issue and as GMLP continues to operate in accordance with current business and financial strategies. The confirmation of GMi’s Commercial Paper rating is based on the credit strength of GMi, as well as the credit facility backing the commercial paper program, as this credit facility is also guaranteed by GMLP.

GMLP has experienced some weakness of earnings in its domestic gas distribution business over the last two years, which remains sensitive to lower return on equity due to interest rates and volume throughputs. In addition, short-term profitability remains a challenge at its 38.3% owned Portland Natural Gas Transmission System (PNGTS). As a result of earnings pressure from these factors, management reduced distributions by 9% in May 2006 in order to preserve the equity base of GMLP. This near-term weakness is expected to be partially offset with the completion of the 550 MW Bécancour cogeneration plant. Representing GMLP’s largest customer, this facility will contribute to both earnings and cash flow as deliveries are expected to increase by 15%.

GMLP continues to explore ways to diversify its operations by implementing its strategy in becoming an integrated energy provider. Strategic diversification should improve GMLP’s overall business profile, as both geographical and operational diversification benefits are expected from the proposed acquisition of Green Mountain Power Corporation (Green Mountain), expected to close shortly. Other projects under consideration include the Rabaska LNG terminal and Seigneurie de Beaupré wind farm. DBRS notes that while an increase in leverage is anticipated as the Green Mountain acquisition is expected to be financed with debt at closing, we expect this increase to be temporary as GMLP has already indicated that it will finance the acquisition with a mix of debt and equity.

DBRS will publish separate GMi and GMLP reports shortly that will provide additional analytical detail on these rating actions. If you are interested in receiving this report, contact us at info@dbrs.com.