HYDRO ONE LTD. Crown jewel utility + consolidation upside

Transcription

1 November 16, 2015 HYDRO ONE LTD. Crown jewel utility + consolidation upside INITIATING COVERAGE H (TSX-H): $22.03 Stock Rating: Outperform Risk Rating: Average 12-Month Target: $ Month Total Return: 21.8% (including 3.8% cash yield) Shares O/S (FD): Mln Market Cap: $13.1 Bln HIGHLIGHTS Highly stable cash flows: Rate regulated Hydro One is the largest electricity transmission and distribution utility in Ontario with ~95% and ~25% market share, respectively. Cash flows are virtually all cost-of-service (i.e., highly stable and predictable). IPO of 15% stake at $20.50/sh: Prior to the IPO on Nov. 5th, the Company had been fully owned by the Province of Ontario, which intends to reduce its interest over time to ~40%, subject to a 180-day lock-up period following IPO (i.e., May 3, 2016). Based on the Governance Agreement, the Province is considered an investor, not a manager. New leadership: Mr. Mayo Schmidt was appointed President and CEO on Aug. 20, 2015, and prior to, served as President, CEO and director at Viterra Inc. from 2000 to Mr. Michael Vels was appointed CFO on June 23, 2015, and prior to, served as CFO at Maple Leaf Foods Inc. from 2004 to Steady organic growth: Hydro One is undertaking a five-year capex program of $7.7 billion (~$1.5 billion per year), underpinning 4% annual organic rate base growth and supporting our forecast 5% annual dividend growth rate through 2019e, while maintaining an earnings payout at the low end of Hydro One's 70-80% target range. Investment stance: Based on a group-low cash flow risk profile (>99% cost-of-service) and "A" credit ratings, we assign a group-high 2016e EV/Free-EBITDA valuation multiple of 18.5x (group: 14.7x) - currently trading at 17.6x (group: 13.2x). Meanwhile, with Ontario promoting the consolidation of LDCs (local distribution companies) via tax-based incentives, we add $1.50/sh of risked M&A upside (~5%) to our base $24.50/sh valuation. EQUITY RESEARCH We are initiating coverage of Hydro One with a $26 target. Based on a potential 12-month total return opportunity of 22%, combined with a group-low cash flow risk profile, we are initiating coverage with an Outperform rating. Patrick Kenny, CFA patrick.kenny@nbc.ca Associate: Michael Nguyen michael.nguyen@nbc.ca

2 TABLE OF CONTENTS EXECUTIVE SUMMARY 2 Overview 2 Growth outlook: Steady mid-single digit organic growth 2 Investment Stance crown jewel utility + consolidation upside 3 HYDRO ONE LTD. 4 Background 4 Ontario electricity market 5 Overview of business operations 6 Growth outlook 10 Financial profile 14 Capital structure 16 Liquidity analysis 16 Dividend policy 17 Valuation summary 17 Investment stance crown jewel utility + consolidation upside 21 MARKET COMPARABLES 22 INVESTMENT RISKS 23 APPENDIX I 24 APPENDIX II 25 APPENDIX III 26 DISCLOSURES 27 Industry Rating (Utilities): Underweight (NBF Economics & Strategy Group) All dollar amounts in Cdn$ unless otherwise noted. All pricing as at November 11, All NBF research mentioned in this document is available at

3 HYDRO ONE LTD. Stock Information Company Profile NBF Research Stock Ticker: H Hydro One Ltd. is a holding company that owns a 100% interest in rateregulated Analyst: Last Closing Price (TSX): $22.03 Hydro One Inc. and non-rate-regulated Hydro One Telecom Inc. Patrick Kenny, CFA (403) Stock Rating: OP Hydro One Ltd. s core asset, Hydro One Inc., is the largest electricity transmission and distribution utility in Ontario and represents >99% of Hydro patrick.kenny@nbc.ca Risk Rating: A One s business. Prior to its initial public offering (IPO) on Nov. 5, 2015, 12-Month Target: $26.00 Hydro One Inc., was fully owned by the Province of Ontario since the Associate: 12-Month Total Return: 21.8% reorganization of Ontario Hydro in Michael Nguyen (416) Shares Outstanding (mln): 595 michael.nguyen@nbc.ca Market Capitalization (C$mln): 13,108 Company Contacts Enterprise Value (C$mln): 23,331 President, CEO and Director: Mayo Schmidt Dividend Yield: 3.8% CFO: Michael Vels Financial Estimates (Cdn$ millions) Valuation Q1/15 Q2/15 Q3/15e Q4/15e 2015e Q1/16e Q2/16e Q3/16e Q4/16e 2016e Stock price n/a n/a n/a n/a n/a $22.03 $22.03 $22.03 $22.03 $22.03 $22.03 $22.03 P/E (1) n/a n/a n/a n/a n/a 19.6x 19.6x 20.4x 19.8x 18.1x 18.7x 18.7x P/CF (1) n/a n/a n/a n/a n/a 8.9x 8.9x 6.9x 7.3x 8.1x 8.2x 8.2x P/AFFO (1)(2) n/a n/a n/a n/a n/a 16.8x 16.8x 12.8x 14.7x 14.6x 15.1x 15.1x EV/EBITDA (1) n/a n/a n/a n/a n/a 11.8x 11.8x 9.3x 9.7x 11.4x 11.6x 11.6x EV/Free-EBITDA (1)(2) n/a n/a n/a n/a n/a 18.4x 18.4x 14.3x 15.3x 17.4x 17.9x 17.9x Dividend yield n/a n/a n/a n/a n/a 0.8% 0.8% 3.8% 3.8% 3.8% 3.8% 3.8% Leverage & Coverage Q1/15 Q2/15 Q3/15e Q4/15e 2015e Q1/16e Q2/16e Q3/16e Q4/16e 2016e Net Debt/EBITDA (3) 4.3x 4.5x 4.4x 4.4x 4.5x 5.1x 5.1x 5.2x 5.1x 5.0x 5.1x 5.1x CF/Interest (3) 4.7x 4.3x 4.4x 4.7x 4.6x 4.6x 4.6x 4.4x 4.6x 4.8x 4.8x 4.8x D/Cap 54% 53% 52% 52% 52% 57% 57% 57% 57% 57% 58% 58% Capitalization Q1/15 Q2/15 Q3/15e Q4/15e 2015e Q1/16e Q2/16e Q3/16e Q4/16e 2016e Weighted average shares - basic (4) Weighted average shares - FD (4) Ending shares - basic (4) Ending shares - FD (4) Enterprise value n/a n/a n/a n/a n/a 23,331 23,331 23,409 23,546 23,625 23,764 23,764 Market capitalization n/a n/a n/a n/a n/a 13,108 13,108 13,108 13,108 13,108 13,108 13,108 Net debt 8,240 8,638 8,484 8,701 8,793 9,829 9,829 9,907 10,044 10,123 10,262 10,262 Preferred equity NCI Dividends Q1/15 Q2/15 Q3/15e Q4/15e 2015e Q1/16e Q2/16e Q3/16e Q4/16e 2016e Dividends Dividend per share $0.34 $0.45 $0.04 $0.04 $0.04 $0.04 $0.17 $0.21 $0.21 $0.21 $0.21 $0.84 DRIP (5) % DRIP participation 0% 0% 0% 0% 0% 0% 0% 30% 30% 30% 30% 30% FFO payout ratio (6) 15% 21% 5% 9% 8% 6% 7% 29% 34% 29% 34% 31% AFFO payout ratio (6) 27% 44% 8% 29% 16% 12% 13% 50% 66% 51% 67% 57% Earnings payout ratio (6) 25% 37% 11% 19% 18% 15% 15% 62% 83% 62% 84% 71% Income Statement Q1/15 Q2/15 Q3/15e Q4/15e 2015e Q1/16e Q2/16e Q3/16e Q4/16e 2016e Adj. EBITDA by segment Transmission 1,154 1, , ,230 Distribution Telecom (2) - - (2) Adj. EBITDA 1,948 1, , ,056 y/y % chg. 3% -1% 5% 9% -3% -3% 2% -3% 9% 18% -4% 4% Depreciation & amortization (676) (722) (187) (190) (191) (191) (759) (199) (199) (199) (199) (794) Interest (7) (378) (397) (98) (98) (107) (113) (415) (107) (108) (108) (109) (432) Taxes (109) (89) (45) (23) (25) (30) (123) (36) (27) (36) (26) (125) NCI - 2 (2) (1) (1) (1) (5) (1) (1) (1) (1) (4) Adj. Net Earnings Adj. EPS - FD $1.32 $1.23 $0.38 $0.22 $0.23 $0.28 $1.12 $0.34 $0.25 $0.34 $0.25 $1.18 Cash Flow Statement Q1/15 Q2/15 Q3/15e Q4/15e 2015e Q1/16e Q2/16e Q3/16e Q4/16e 2016e Funds from operations (FFO) 1,375 1, , ,602 Maintenance capital expenditures (627) (687) (164) (188) (173) (173) (699) (183) (183) (183) (183) (732) Adj. funds from operations (AFFO) (2) Investing activities (812) (683) (189) (300) (224) (224) (938) (201) (201) (201) (201) (803) Financing activities 369 (377) (25) (225) 47 (125) (125) (125) (125) (500) FFO/sh - FD $2.31 $2.18 $0.82 $0.46 $0.56 $0.65 $2.48 $0.72 $0.62 $0.72 $0.62 $2.69 AFFO/sh - FD (2) $1.26 $1.02 $0.54 $0.14 $0.26 $0.36 $1.31 $0.42 $0.32 $0.41 $0.31 $1.46 Balance Sheet Q1/15 Q2/15 Q3/15e Q4/15e 2015e Q1/16e Q2/16e Q3/16e Q4/16e 2016e Working capital 61 (265) (561) (428) (520) (756) (756) (834) (971) (1,050) (1,189) (1,189) PP&E 16,431 17,401 17,587 17,907 18,114 18,320 18,320 18,506 18,691 18,876 19,062 19,062 Other assets 3,136 3,699 3,702 3,676 3,676 3,676 3,676 3,676 3,676 3,676 3,676 3,676 Total Assets 19,628 20,835 20,728 21,155 21,270 21,240 21,240 21,348 21,396 21,502 21,548 21,548 Long-term debt 8,301 8,373 7,923 8,273 8,273 9,073 9,073 9,073 9,073 9,073 9,073 9,073 Other liabilities 3,912 4,515 4,653 4,625 4,626 4,652 4,652 4,682 4,705 4,735 4,758 4,758 Preferred equity Equity 7,092 7,553 7,757 7,863 7,977 7,121 7,121 7,199 7,224 7,300 7,324 7,324 NCI Total Liabilities and Equity 19,628 20,835 20,728 21,155 21,270 21,240 21,240 21,348 21,396 21,502 21,548 21,548 (1) Based on 12-month trailing figures. (2) AFFO = FFO less Maintenance capex; Free-EBITDA = EBITDA less Maintenance capex. (3) Preferred equity treated as 50% debt. (4) Retro adjustment for share count. (5) Common shares paid in lieu of cash dividends will be purchased from the open market and not issued from treasury. (6) FFO payout ratio = Total dividends / FFO; AFFO payout ratio = Total dividends / AFFO; Earnings payout ratio = Total dividends / Net earnings. (7) Includes preferred equity dividends. Source: Company Reports, NBF Estimates, ThomsonOne PATRICK KENNY 1

4 EXECUTIVE SUMMARY Overview Hydro One Ltd. (Hydro One; H: TSX) is a holding company that owns a 100% interest in rateregulated Hydro One Inc. the largest electricity transmission and distribution utility in Ontario with Transmission and Distribution representing over 99% of Hydro One s 2016e EBITDA. As such, the Company s cash flows are virtually all cost-of-service (i.e., highly stable and predictable). Prior to Hydro One s IPO (initial public offering) of a 15% stake on Nov. 5, 2015, the Company had been fully owned by the Province of Ontario since the reorganization of Ontario Hydro in ELECTRICITY VALUE CHAIN Hydro One Inc. HYDRO ONE - SEGEMENTED 2016E EBITDA Distribution 41% Generation Nuclear Hydro Gas Wind Transmission High Voltage Distribution Lower Voltage Retailing Industrial Residential Commercial Transmission 59% Telecom 0% Source: NBF Hydro One s allowable ROEs (return on equity) for Transmission and Distribution have averaged 9.33% and 9.59%, respectively, over the past five years versus the Canadian peer average of ~9% suggesting a relatively attractive regulatory jurisdiction. Meanwhile, Hydro One s realized ROE has averaged ~12% over the past five years largely reflecting higher weather-related peak demand within Transmission. For 2016e, we forecast a realized consolidated ROE of ~10% versus the projected allowable ROEs of 9.19%. CANADIAN RATE-REGULATED ELECTRICITY ROE SEGMENT AND OVERALL REALIZED ROE ROE 5-yr Range Overall Avg. 5-yr Avg % Transmission Distribution Integrated Utility 10.00% 9.50% 9.00% 8.50% ROE 20.00% 16.00% 12.00% 8.00% 8.39% 9.85% 11.64% Transmission Distribution Hydro One 9.66% 9.66% 11.85% 9.42% 9.66% 12.67% 8.93% 9.66% 12.81% 9.36% 9.66% 11.18% 9.30% 9.30% 9.78% 9.19% 9.19% 9.85% 8.00% 7.50% 4.00% HYO - ON CU - AB HYO - ON CU - AB FTS - AB FTS - BC FTS - NF FTS - ON EMA - NS 0.00% e 2016e Source: Company Reports Source: Company Reports Growth outlook: Steady mid-single digit organic growth Hydro One is undertaking a five-year capital investment program of $7.7 billion with annual investments averaging ~$1.5 billion per year through 2019 all self-funding (i.e., no external equity needed), underpinning 4% annual organic growth in the Company s rate base through 2019e to $20.1 billion from 2014 levels of $16.3 billion (see following figure). Overall, we forecast 5% annual dividend growth through 2019e, while maintaining an earnings payout ratio at the low end of the Company s 70-80% target range. 2 PATRICK KENNY

5 5-YR SEGMENTED CAPEX PROGRAM RATE BASE GROWTH FORECAST $mln 2,100 1,750 1,400 1, ,564 Transmission 1,535 1, Distribution 678 1,517 1, $bln CAGR: 7% yr CAGR: 4% e 2016e 2017e 2018e 2019e e 2016e 2017e 2018e 2019e Source: Company Reports Source: Company Reports, NBF Estimates Investment Stance crown jewel utility + consolidation upside With a group-low cash flow risk profile (over 99% cost-of-service) and A credit ratings, we assign a group-high valuation multiple of 18.5x EV/Free-EBITDA (5.0% WACC) versus the group at 14.7x (6.1% WACC). WEIGHTED AVERAGE COST OF CAPITAL FREE-EBITDA MULTIPLE 10.0% High-payout: Low-payout: 20.0x High-payout: Low-payout: 8.0% 16.0x Avg.: 14.7x 6.0% Avg.: 6.1% 12.0x 4.0% 8.0x 2.0% 4.0x 0.0% 0.0x H FTS CU EMA ENB ACO VNR IPL ENF TRP ALA VSN KEY TA CPX GEI TWM H ENF ENB IPL VNR FTS ALA EMA KEY CU ACO VSN TRP GEI CPX TWM TA Note: NBF Research restricted on CUS, PPL and SPB. Note: NBF Research restricted on CUS, PPL and SPB. Meanwhile, Ontario is promoting the consolidation of LDCs (local distribution companies) by reducing the transfer tax rate over the next three years to 22% (from 33%), while exempting transfer taxes and capital gains portion of the departure tax for acquired LDCs with less than 30,000 customers. In total, we highlight ~70 LDCs in Ontario, generating over $1 billion of EBITDA, and representing ~35% blue sky unrisked M&A upside based on precedent transaction multiples of ~11.5x EBITDA (~9.5x including transfer tax). Assuming Hydro One captures one-third market share, and applying a 50% risk-weighting, we include $1.50/sh of M&A upside within our $26.00 target. Based on a 12-month total return of 21.8%, combined with a group-low cash flow risk profile, we initiate coverage of Hydro One with an Outperform rating. LDC'S WITH <30K CUSTOMERS - M&A DCF SENSITIVITY LDC'S WITH >30K CUSTOMERS - M&A DCF SENSITIVITY Transaction Value ($mln) Transaction Value (1) ($mln) ,000 1,250 7,000 8,000 9,000 10,000 11, x $0.25 $0.50 $0.75 $1.00 $ x $6.50 $7.50 $8.50 $9.50 $ x $0.25 $0.50 $0.50 $0.75 $ x $5.75 $6.50 $7.25 $8.25 $ x $0.25 $0.25 $0.50 $0.75 $ x $5.00 $5.75 $6.25 $7.00 $ x $0.25 $0.25 $0.50 $0.75 $ x $4.25 $4.75 $5.50 $6.00 $ x $0.25 $0.25 $0.50 $0.50 $ x $3.50 $4.00 $4.50 $5.00 $5.75 (1) Includes 22% transfer tax. EV/EBITDA Transaction VALUATION SUMMARY Methodology Metric Valuation DDM 3.5% $24.50 EV/Free-EBITDA 18.5x $24.00 DCF Model 5.00% $25.00 Equally Weighted Avg. $24.50 Risked upside 50% $1.50 Risked Target $26.00 PATRICK KENNY 3 EV/EBITDA Transaction

6 HYDRO ONE LTD. Background Hydro One Ltd. (Hydro One; H: TSX) is a holding company that owns a 100% interest in rateregulated Hydro One Inc. and non-rate-regulated Hydro One Telecom Inc. (see diagram below). Hydro One Inc. is the largest electricity transmission and distribution utility in Ontario and represents ~99% of Hydro One s business. Prior to its IPO (initial public offering) on Nov. 5, 2015, Hydro One s main subsidiary, Hydro One Inc., had been fully owned by the Province of Ontario since the reorganization of Ontario Hydro in HYDRO ONE CORPORATE STRUCTURE Source: Company Reports IPO of 15% stake at $20.50/sh Hydro One s Nov. 5 th IPO marked the sale of a 15% stake from the Province of Ontario, which raised gross proceeds of ~$1.8 billion at $20.50/share implying a total equity value of $12 billion for Hydro One. Looking ahead, the Province of Ontario intends to reduce its overall interest in Hydro One over time to ~40% (from 85%), while being subject to a 180-day lock-up period following closing of the IPO (i.e., expiring May 3, 2016). Of note, prior to the sale of Hydro One Ltd. shares, Hydro One Brampton Networks Inc. was carved out of Hydro One Inc. s distribution business, and is currently fully owned by the Province of Ontario. Hydro One Brampton Networks is a local distribution company with ~150,000 customers, representing ~10% of Hydro One s distribution customer base. Is Big Brother watching? Despite the Province of Ontario maintaining a controlling interest, Hydro One will operate as an independent, commercially oriented public company with the ability for autonomous decision-making, albeit with certain caveats. In other words, the Province is to be considered an investor in Hydro One, not a manager. To maintain and support Hydro One s presence in Ontario, the Ontario Electricity Act requires Hydro One s head office and principle grid control centre to remain in Ontario prohibiting any change to Hydro One s jurisdiction of incorporation. As such, the Company is restricted from selling all or substantially all of its assets that are regulated by the Ontario Energy Board while no single stakeholder can own more than 10% of voting class securities in Hydro One, excluding the Province of Ontario who must maintain a minimum interest in the Company of at least 40%. On the governance front, Hydro One and the Province of Ontario signed the Governance Agreement which, among other things, allows Ontario to nominate 40% of the directors within the Board of Directors (comprised of directors) that must be independent of the Company and the Province (excluding the CEO). Furthermore, the Province has agreed not to initiate fundamental changes to Hydro One; however, the Province is still entitled to vote on fundamental change matters. 4 PATRICK KENNY

7 New leadership Mr. Mayo Schmidt was appointed the President and CEO of Hydro One on Aug. 20, Prior to joining Hydro One, Mr. Schmidt served as President, CEO and director at Viterra Inc., a global food ingredients company, from January 2000 to December 2012, when it was acquired by Glencore International plc. During his tenure at Viterra, Mr. Schmidt transformed the regional agriculture and food business to a global leader, boosting the Company s total enterprise value from under $200 million in 2000 to ~$7.5 billion. Mr. Michael Vels was appointed CFO of Hydro One on June 23, Prior to joining Hydro One, Mr. Vels served as CFO at Maple Leaf Foods Inc. from 2004 to During his tenure at Maple Leaf Foods Inc., Mr. Vels oversaw numerous M&A transactions, including ~$3 billion of divestitures. For more details on senior management and directors at Hydro One, please see Appendix I. Ontario electricity market Clearing the way for more competition In 1998, the Province of Ontario began to promote competition within its electricity market with the introduction of its Electricity Act, resulting in the split-up of Ontario Hydro, the Crown-owned corporation largely responsible for supplying Ontario with electricity generation, transmission and distribution, into five separate entities most notably: 1) Hydro One Inc., the successor to its transmission and distribution businesses; 2) Ontario Power Generation Inc., the successor to its power generation business; and 3) The Independent Electricity System Operator (IESO), focused on electricity system dispatch (see diagram below). RESTRUCTURING OF ONTARIO HYDRO Ontario Hydro Hydro One (Transmission + Distribution) Ontario Power Generation (Generation) Independent Electricity System Operator (System Dispatch) Ontario Electrical Safety Association (Safety) Ontario Electricity Financial Corporation (Debt Retirement) Source: Ontario Energy Board Regulatory framework Ontario s electricity market is overseen by three main regulatory authorities, as highlighted below: Ontario Energy Board (OEB) Established in 1960, the OEB is an independent and impartial public regulatory agency responsible for the regulation of natural gas and electric utilities in Ontario. As such, the OEB is responsible for, among other things, approving: 1) transmission and distribution rates; 2) construction, expansion or reinforcement of transmission lines greater than two kilometres in length; and 3) mergers, acquisitions, amalgamations and divestitures involving distributors and other entities which it licenses. Overall, the OEB sets its ROE based on a formula linked to long-term government bond yields and corporate spreads, creating a relatively stable and predictable rate. All else equal, compared to its Canadian peers in various Canadian jurisdictions, Hydro One s five-year range of allowable ROEs have been relatively more stable with Transmission and Distribution ROEs ranging from 73 bps and 36 bps, respectively, versus the overall average of 81 bps suggesting a relatively stable regulatory jurisdiction. Meanwhile, Hydro One s allowable ROEs for Transmission and Distribution has averaged 9.33% and 9.59%, respectively, over the past five years versus the overall average of ~9% suggesting a relatively PATRICK KENNY 5

8 attractive regulatory jurisdiction. Furthermore, Hydro One s realized ROE has averaged ~12% over the past five years largely reflecting higher weather-related peak demand within Transmission. For 2016e, we conservatively forecast a realized consolidated ROE of 9.85% versus the projected allowable ROEs of 9.19%. CANADIAN RATE-REGULATED ELECTRICITY ROE SEGMENT AND OVERALL REALIZED ROE ROE 5-yr Range Overall Avg. 5-yr Avg % Transmission Distribution Integrated Utility 10.00% 9.50% 9.00% 8.50% ROE 20.00% 16.00% 12.00% 8.00% 8.39% 9.85% 11.64% Transmission Distribution Hydro One 9.66% 9.66% 11.85% 9.42% 9.66% 12.67% 8.93% 9.66% 12.81% 9.36% 9.66% 11.18% 9.30% 9.30% 9.78% 9.19% 9.19% 9.85% 8.00% 7.50% 4.00% HYO - ON CU - AB HYO - ON CU - AB FTS - AB FTS - BC FTS - NF FTS - ON EMA - NS 0.00% e 2016e Source: Company Reports Source: Company Reports Independent Electricity System Operator (IESO) The IESO is a not-for-profit Crown corporation created from the split-up of Ontario Hydro in 1998, and mandated to, among other things, manage the operation and reliability of Ontario s bulk power system and oversee the wholesale electricity market by balancing the supply and demand of electricity in Ontario ergo determining the price of electricity. IESO is governed by an independent board whose chair and directors are appointed by the Province of Ontario. In 2015, the IESO merged with Ontario Power Authority (OPA) and is now responsible for integrated medium and long-term power system planning in Ontario, including the procurement of new sources of electricity supply and transmission capacity. National Energy Board (NEB) Founded in 1959, the National Energy Board (NEB) is an independent federal agency responsible for regulating the Canadian energy industry under federal jurisdiction, including the construction and operation of international and interprovincial power lines deemed under federal jurisdiction. Hydro One owns and operates 11 active international power lines connecting Ontario s grid with Michigan, Minnesota and New York. Overview of business operations The electricity industry value chain is comprised of four main businesses: 1) Generation: electricity production; 2) Transmission: long haul transportation of electricity; 3) Distribution: delivery of electricity to end users; and 4) Retailing: sale of electricity to consumers. Overall, Hydro One s current operations are focused on Transmission and Distribution, representing over 99% of its overall business based on 2016e EBITDA, while the remainder of the Company is comprised of its non-rateregulated Telecom business. Below we highlight further details of each business unit. ELECTRICITY VALUE CHAIN Hydro One Inc. HYDRO ONE - SEGEMENTED 2016E EBITDA Distribution 41% Generation Nuclear Hydro Gas Wind Transmission High Voltage Distribution Lower Voltage Retailing Industrial Residential Commercial Transmission 59% Telecom 0% Source: NBF 6 PATRICK KENNY

9 Transmission the bread and butter Hydro One s transmission business represents ~60% of 2016e EBITDA, and is comprised of ~291 transmission stations and ~29,000 km of high voltage lines that account for 96% of Ontario s transmission network. The Transmission business also includes Hydro One s 66% interest in B2M (Bruce-to-Milton) LP, a limited partnership between Hydro One and the Saugeen Ojibway Nation, which largely owns all the assets related to the Bruce-to-Milton transmission line. Electricity delivered over Hydro One s transmission network is sourced from 116 generators across Ontario and delivers power to 48 local distribution companies (LDCs; including Hydro One s distribution business) and 90 large industrial customers. Hydro One s network, controlled from a central location north of Toronto, is connected to Manitoba, Michigan, Minnesota, New York and Québec, allowing for the import and export of electricity. HYDRO ONE TRANSMISSION MAP BRUCE-TO-MILTON TRANSMISSION MAP Source: Company Reports Source: Company Reports Transmission rates in Ontario are based on a cost-of-service model approved by the OEB. Hydro One typically files a rate application every two years for transmission rates, which cover the prospective two-year period. 1) In part one of the application process, all transmitters in Ontario apply for approval of their revenue requirements, which covers the transmitters costs of providing service and an allowed return on equity. Once approved, the revenue requirements generally cover the subsequent twoyear period with adjustments to occur in the second year to update for current cost of debt and return on equity. 2) Next, the OEB aggregates the revenue requirements of all transmitters in Ontario to arrive at a single uniform transmission rate. On Jan. 8, 2015, the OEB approved Hydro One s 2015 to 2016 transmission rate order which calls for a revenue requirement of $1,477 million for 2015 and $1,516 million for 2016 reflecting an approved rate base for 2015 of $9,651 million, ROE of 9.30% and an equity thickness of 40% (i.e., 60/40 debt/equity). Meanwhile, B2M LP filed its 2015 to 2017 rate order in March 2015, and expects a decision in Q Overall, Hydro One s transmission allowable ROE has averaged 9.33% over the past five years and has ranged from a low of 8.93% to a high of 9.66%. Transmission rates are based on monthly peak electricity demand forecast across Hydro One s transmission network below we highlight the historical five-year average monthly peak demand across Ontario, noting modest quarterly seasonality throughout a year. PATRICK KENNY 7

10 TRANSMISSION - 5-YR ALLOWED ROE & EQUITY ONTARIO - 5-YR AVERAGE MONTHLY PEAK DEMAND ROE 9.66% 9.42% 8.93% 9.36% 9.30% Equity 40% 40% 40% 40% 40% 5-yr Avg. ROE 9.33% Source: Company Report MW 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Seasonality Q1: 25% Q2: 24% Q3: 27% Q4: 23% Jan. Feb. Mar. Apr. May Jun. Jul. Aug. Sep. Oct. Nov. Dec. Note: For the period of Source: IESO Of note, the projected allowable ROE for 2016 is 9.19% based on the OEB s cost of capital parameter calculations and applying long-term bond yields and yield spreads as at September For 2017, we calculate a move back towards 9.30% based on our Economics & Strategy Group s forecast. OEB - ALLOWABLE ROE CALCULATION (%) 2016e 2017e 30-yr GCAN forecast (LCBF) Initial ROE Change in LCBF Current Base Difference x Difference Change in A-rated Utility Bond Yield Spread Current Spread Base A-rated Utility Spread Difference x Difference Revised ROE Source: Company Reports, OEB, NBF Estimates Distribution The Distribution business represents ~40% of Hydro One s 2016e EBITDA, and includes ~122,000 circuit kms of low-voltage distribution lines and ~1,000 distribution and regulating stations serving ~1.3 million residential and business customers, whom are mostly in rural areas, and 56 local distribution companies. Given that a large portion of Hydro One s distribution system services rural areas of Ontario, costs to provide services are typically higher than other competing distributors who service urban areas. Furthermore, Hydro One s distribution system is not designed to be interconnected in loops with other distribution lines, resulting in downstream disruptions when a portion of the distribution line is interrupted. As such, the Company must engage in significant vegetation management (i.e., trimming or removal of trees near distribution lines) in order to mitigate disruptions to its distribution system. HYDRO ONE DISTRIBUTION MAP Source: Company Reports 8 PATRICK KENNY

11 Distribution rates in Ontario are set on a performance-based model approved by the OEB. The application process is similar to the transmission rate applications, although with key differences as highlighted below. 1) Distribution rate applications typically span five-year periods. 2) Revenue requirements are approved only for the first year, while subsequent years are determined by a formula that factors in inflation and certain productivity factors. 3) The utility is allowed to retain all or a portion of cost savings achieved in excess of those established by the regulatory i.e., potential to earn above the set allowable ROE. On March 12, 2015, the OEB issued a decision on Hydro One s distribution rates for 2015 to 2017 which calls for a revenue requirement of $1,326 million for 2015, $1,430 million for 2016 and $1,486 million for 2017 reflecting an approved rate base for 2015 of $6,552 million, ROE of 9.30% and an equity thickness of 40%. However, the OEB did not consider Hydro One s application to be sufficiently aligned with the objectives of the Renewed Regulatory Framework for Electricity Distributors: A Performance-Based Approach (October 2012) and therefore applied a cost-of-service methodology. That said, Hydro One anticipates that rates beyond 2017 (i.e., for the 2018 to 2022 timeframe) will be set under the performance-based model. Overall, Hydro One s distribution ROE has averaged 9.59% over the past five years of allowable ROEs and has ranged from a low of 9.30% to a high of 9.66%. Of note, the projected allowable ROE for 2016 is 9.19% based on the OEB s cost of capital parameter calculations (see calculation above). DISTRIBUTION - 5-YR ALLOWED ROE & EQUITY ROE 9.66% 9.66% 9.66% 9.66% 9.30% Equity 40% 40% 40% 40% 40% 5-yr Avg. ROE 9.59% Source: Company Report Telecom Representing less than 1% of the Company s 2016e EBITDA, the Telecom segment is comprised of fibre-optics network assets that deliver telecommunications solutions to Hydro One, carriers, financial institutions, enterprises, public sector organizations, utilities and more. Unions & Labour agreements The majority (>90%) of Hydro One s total workforce of ~8,800 are represented by unions that include: 1) Power Workers Union; 2) The Society of Energy Professionals; and 3) Canadian Union of Skilled Workers and construction building trade unions. Below we highlight each union and recent collective agreements. Power Workers Union The Power Workers Union (PWU) represents the majority of Hydro One s workforce with ~5,400 employees under its umbrella. On April 14, 2015, Hydro One and the PWU reached an agreement for a renewal of their collective agreement that covers a three-year period (April 1, 2015 to March 31, 2018) providing an average annual wage increase of 1%, largely offset by an increase in annual employee pension contributions (i.e., moving to or close to 50/50 contributions from employer/employee). PATRICK KENNY 9

12 The Society of Energy Professionals The Society of Energy Professionals (SEP) represents ~1,500 of Hydro One s workforce that are professional and first-level supervisory staff. On July 24, 2015, Hydro One and the SEP reached an agreement for an early renewal of their collective agreement that covers a three-year period (April 1, 2016 to March 31, 2019) providing an average annual wage increase of 0.5%, largely offset by an increase in annual employee pension contributions (i.e., moving to or close to 50/50 contributions from employer/employee). Canadian Union of Skilled Workers and construction building trade unions The Canadian Union of Skilled Workers and construction building trade unions represents ~1,400 of Hydro One s workforce. On July 28, 2015, Hydro One and the Canadian Union of Skilled Workers reached an agreement for a renewal of their collective agreement that covers a three-year period (May 1, 2014 to April 30, 2017) the agreement was ratified by the board of directors of Hydro One, but remains subject to ratification by the Canadian Union of Skilled Workers. Elsewhere, negotiations and ratifications for the renewal of various collective agreements with various construction building trade unions have commenced and are ongoing. Growth outlook Self-funding ~$7.7 billion capex program underpins ~4% rate base CAGR through 2019 Hydro One is undertaking a five-year capital investment program of $7.7 billion with annual investments averaging ~$1.5 billion per year through 2019 all self-funding (i.e., no external equity needed), underpinning 4% annual organic growth in the Company s rate base through 2019 to $20.1 billion from 2014 levels of $16.3 billion. Of note, $4.3 billion (56%) of capital investments are earmarked for the Transmission business, with the remaining $3.4 billion (44%) targeting the Distribution business. 5-YR SEGMENTED CAPEX PROGRAM RATE BASE GROWTH FORECAST $mln 2,100 1,750 1,400 1, ,564 Transmission 1,535 1, Distribution 678 1,517 1, $bln CAGR: 7% yr CAGR: 4% e 2016e 2017e 2018e 2019e e 2016e 2017e 2018e 2019e Source: Company Reports Source: Company Reports, NBF Estimates Aging infrastructure hungry for sustaining capital With a large portion of Hydro One s transmission and distribution assets built in the 1960s and 1970s (or earlier), the Company expects to continue making large investments in its sustaining capex program. Overall, total sustaining capital expenditures through 2019 are expected to be $4.8 billion, representing ~60% of the total $7.7 billion of capital investments, and ~115% of the total $4.1 billion of depreciation expense over the same timeframe. With all capital expenditures included in rate base, we classify excess sustaining capital over and above depreciation as growth capital as it is additive to the rate base while involving less regulatory and execution risk compared to the growth capital program. Of note, our maintenance capex assumptions track the Company s depreciation expense (expenditures required to keep rate base flat). Longer term, we call for a sustaining capex run-rate of ~20% above depreciation expense. 10 PATRICK KENNY

13 RATE BASE GROWTH FORECAST 5-YR SUSTAINING CAPEX VS DEPRECIATION $bln 21 Rate Base Capex Depreciation $mln 1,500 Sustaining Capex Depreciation ,250 1, a 2015e 2016e 2017e 2018e e 1, e 2016e 2017e 2018e 2019e Source: Company Reports, NBF Estimates Source: Company Reports Organic growth On the organic growth front, Hydro One expects to invest $2.0 billion over the five-year period towards development projects within its Transmission and Distribution businesses additions to existing assets and large-scale projects such as new transmission lines and transmission stations as well as ~$0.9 billion of investments in other projects (IT / operational efficiencies; all included in rate base). In the following figure, we highlight Hydro One s five-year growth capex program and current slate of major transmission projects. 5-YR GROWTH CAPEX PROGRAM HYDRO ONE - MAJOR TRANSMISSION PROJECTS $mln e e T&D Growth 2017e Other Growth 2018e e Project Type In-service Capex Toronto Midtown Transmission New Transmission Line 2016 $123-mln Reinforcement Guelph Area Transmission Transmission Line 2016 $103-mln Refurbishment Upgrade Manby Transmission Station Transmission Station 2016 $24-mln Upgrade Clarington Transmission Station New Transmission 2018/2019 $297-mln Station Supply to Essex County New Transmission Line 2018 TBD Transmission Reinforcement and Station Northwest Bulk Transmission New Transmission Line early-2020 TBD Line Source: Company Reports Source: Company Reports Looking further out, Ontario s peak electricity demand is forecasted to grow to ~30,000 MW by 2032e, a 1.5% CAGR from 2014 peak demand of 22,774 MW. The 1.5% CAGR is below the longterm real GDP forecast for Ontario of 2.1%, reflecting energy conservation initiatives such as the implementation of smart metre and smart grid technologies i.e., providing customers with information about their electricity usage to enable them to change their consumption patterns and reduce their costs. Based on a four-year historical reserve margin (capacity less peak demand over peak demand) of ~45% we estimate the need for ~43,000 MW of installed generation capacity by 2032, representing incremental generation capacity of ~8,000 MW from current capacity of ~35,000 MW. This is in line with Ontario s latest Long-Term Energy Plan (LTEP), which calls for an increase in renewable generation capacity to ~20,000 MW by 2025 versus current renewable capacity of ~12,000 MW. Generation growth will support upgrades and new connections to Hydro One s Transmission and Distribution networks. PATRICK KENNY 11

14 ONTARIO PEAK DEMAND ELECTRICITY FORECAST MW 50,000 Peak Demand Reserve Margin 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5, e 2016e 2017e 2018e 2019e 2020e 2021e 2022e 2023e 2024e 2025e 2026e 2027e 2028e 2029e 2030e 2031e 2032e ONTARIO INSTALLED GENERATION CAPACITY Gas 9,920 MW 28% Hydro 8,462 MW 24% Wind 3,209 MW 9% Biofuel 455 MW 1% Nuclear 12,978 MW 37% Solar 140 MW 1% Note: Assumes forward reserve margin of 45% (based on 4-yr historical avg.). Note: As of August 14, Source: IESO, NBF Estimates Source: IESO ONTARIO'S LONG-TERM ECONOMIC OUTLOOK Actual Forecast Nominal GDP 5.3% 4.2% 4.1% 3.8% 4.0% 4.1% 4.0% Real GDP 2.6% 2.5% 2.1% 1.9% 2.1% 2.1% 2.1% CPI 3.0% 1.9% 2.0% 2.0% 2.0% 2.0% 2.0% Source: Ontario's Long-term Report on the Economy (2014). ONTARIO'S LONG-TERM POPULATION GROWTH OUTLOOK Source: Ontario's Long-term Report on the Economy (2014). Elsewhere, Ontario s LTEP has made connecting remote northwestern First Nation communities to the grid a priority for Ontario creating further opportunities for Hydro One to expand its Transmission and Distribution footprint. Overall, the province identified ~25 remote First Nation communities in the northwest region that are not connected to the grid and currently draw electricity from on-site diesel fuel generators. KEY AREAS AND PROJECTS IN NORTHWESTERN ONTARIO Source: Ontario's 2013 Long Term Energy Plan 12 PATRICK KENNY

15 M&A upside: LDC consolidation opportunities Ontario currently has ~70 local distribution companies (LDCs) that are mostly owned or jointly owned by municipalities. To improve competition, operational efficiencies, as well as access to private sector capital the Province is promoting the consolidation of LDCs across Ontario, by reducing the transfer tax rate over the next three years to 22% (from 33%), while exempting transfer taxes and capital gains portion of the departure tax for acquired LDCs with less than 30,000 customers. Year-todate, Hydro One completed the acquisition of Haldimand County Hydro (~21k customers) and Woodstock Hydro Services Inc. (~16k customers) at an average EV/2014 EBITDA of ~11.5x (see table below). HYDRO ONE PRECEDENT LCD M&A TRANSACTIONS Takeout Target Date Price '14 EBITDA EV/EBITDA Norfolk Power Distr. 24-Aug-14 $ 93 $ x Haldimand County Hydro 30-Jun-15 $ 75 $ x Woodstock Hydro Serv. 31-Oct-15 $ 46 $ x Average 14.0x Note: Values in mlns. Source: Company Reports In total, we highlight ~40 LDCs remaining in Ontario with less than 30,000 customers and generating an aggregate 2014 EBITDA of ~$100 million (see Appendix II & III for a map and list of all LDCs in Ontario). As such, based on an ~11.5x EV/2014 EBITDA transaction multiple, we highlight over $1 billion of near-term M&A opportunities for Hydro One related to the consolidation of small LDCs in Ontario representing ~$1/sh (~5%) of unrisked upside to our base valuation. Meanwhile, the ~30 LDCs with greater than 30,000 customers represent 2014 EBITDA of ~$950 million, or ~$9 billion of M&A potential based on an after-transfer tax equivalent price tag of 9.5x, representing a further ~$8/sh (~30%) unrisked upside to our valuation. LDC CONSOLIDATION OPPORTUNITIES IN ONTARIO LDCs with less than 30,000 customers LDCs with more than 30,000 customers Aggregate EBITDA (1) 103 Aggregate EBITDA (1) 969 Precedent EV/EBITDA transactions 11.5x Equivalent after-transfer tax EV/EBITDA (2) 9.5x Implied M&A opportunities (pre-tax) 1,183 Implied M&A opportunities (pre-tax) 9,206 Transfer tax rate 0% Transfer tax rate 22% Implied M&A opportunities 1,183 Implied M&A opportunities 11,232 Note: Values in $mln. (1) Based on 2014 EBITDA. (2) Equivalent after-transfer tax multiple to maintain ~11.5x EBITDA economics after a 22% transfer tax. Source: Company Reports, NBF Estimates, OEB LDC'S WITH <30K CUSTOMERS - M&A DCF SENSITIVITY LDC'S WITH >30K CUSTOMERS - M&A DCF SENSITIVITY Transaction Value ($mln) Transaction Value (1) ($mln) ,000 1,250 7,000 8,000 9,000 10,000 11, x $0.25 $0.50 $0.75 $1.00 $ x $6.50 $7.50 $8.50 $9.50 $ x $0.25 $0.50 $0.50 $0.75 $ x $5.75 $6.50 $7.25 $8.25 $ x $0.25 $0.25 $0.50 $0.75 $ x $5.00 $5.75 $6.25 $7.00 $ x $0.25 $0.25 $0.50 $0.75 $ x $4.25 $4.75 $5.50 $6.00 $ x $0.25 $0.25 $0.50 $0.50 $ x $3.50 $4.00 $4.50 $5.00 $5.75 (1) Includes 22% transfer tax. EV/EBITDA Transaction EV/EBITDA Transaction PATRICK KENNY 13

16 Financial profile For 2016, we forecast EPS (FD) and AFFO/sh (FD) of $1.18 and $1.46 on EBITDA of $2,056 million, reflecting modest growth over 2015e levels owing to rate base growth, partially offset by a reduced allowable ROE on both the Transmission and Distribution business (9.19% versus 9.30%). Based on an initial quarterly dividend of $0.21/sh ($0.84/sh annualized), we estimate a 2016e AFFO payout ratio of 57% (group avg.: 48%) and an earnings payout ratio of 71% (group avg.: 89%), sitting at the low end of the Company s target range of 70-80%. On the leverage front, we forecast 2016e Net Debt/EBITDA of 5.1x versus low-payout peers at 6.0x. HYDRO ONE LTD. - FINANCIAL PROFILE HYDRO ONE LTD. STOCK CHART Market Capitalization e 2016e 2017e 2018e 2019e 2020e $/sh Vol. (mln) Stockt Price n/a n/a $22.03 $22.03 $22.03 $22.03 $22.03 $22.03 $ Shares Outstanding - FD $ Market Capitalization n/a n/a 13,108 13,108 13,108 13,108 13,108 13,108 $ Net Debt 8,240 8,638 9,829 10,262 10,644 10,976 11,258 11,547 $ Preferred Equity $ NCI Enterprise Value n/a n/a 23,331 23,764 24,146 24,478 24,760 25,049 $ Financial Information e 2016e 2017e 2018e 2019e 2020e Adj. EBITDA by Segment Transmission 1,154 1,194 1,150 1,230 1,250 1,290 1,330 1,370 Distribution Source: Bloomberg Telecom 2 1 (2) Adj. EBITDA 1,948 1,937 1,970 2,056 2,121 2,192 2,267 2, E EBITDA BY SEGMENT Depreciation & Amortization (676) (722) (759) (794) (826) (858) (892) (892) Interest (1) (378) (397) (415) (432) (433) (433) (431) (457) Taxes (109) (89) (123) (125) (129) (135) (142) (147) NCI - 2 (5) (4) (4) (4) (4) (4) Adj. Net Earnings Realized ROE 12.8% 11.2% 9.8% 9.9% 9.8% 9.9% 10.1% 10.1% Adj. EBITDA 1,948 1,937 1,970 2,056 2,121 2,192 2,267 2,326 Interest (1) (378) (397) (415) (432) (433) (433) (431) (457) Cash Taxes (111) (79) (93) (19) (19) (20) (21) (22) NCI - 2 (5) (4) (4) (4) (4) (4) Other (84) (168) FFO 1,375 1,295 1,477 1,602 1,665 1,735 1,811 1,843 Maintenance Capex (627) (687) (699) (732) (764) (807) (818) (825) AFFO (2) ,018 Dividends E ENTERPRISE STRUCTURE Acquisitions Growth Capex Equity Issued Ending Net Debt (incl. 50% pref.) 8,402 8,800 9,991 10,424 10,805 11,138 11,419 11,709 Net Debt/EBITDA (3) 4.3x 4.5x 5.1x 5.1x 5.1x 5.1x 5.0x 5.0x CF/Interest (3) 4.7x 4.3x 4.6x 4.8x 4.9x 5.1x 5.3x 5.1x D/Cap 54% 53% 57% 58% 58% 58% 58% 58% Per Share e 2016e 2017e 2018e 2019e 2020e Ending Net Debt $13.85 $14.52 $16.52 $17.25 $17.89 $18.45 $18.92 $19.41 EBITDA $3.27 $3.26 $3.31 $3.46 $3.57 $3.68 $3.81 $3.91 EPS - FD $1.32 $1.23 $1.12 $1.18 $1.23 $1.28 $1.34 $1.39 Distribution 40% FFO - FD $2.31 $2.18 $2.48 $2.69 $2.80 $2.92 $3.04 $3.10 AFFO - FD (2) $1.26 $1.02 $1.31 $1.46 $1.52 $1.56 $1.67 $1.71 Dividends $0.34 $0.45 $0.17 $0.84 $0.88 $0.93 $0.97 $ E CASH FLOW RISK PROFILE FFO Payout Ratio (4) 15% 21% 7% 31% 32% 32% 32% 33% AFFO Payout Ratio (4) 27% 44% 13% 57% 58% 59% 58% 60% Margin Earnings Payout Ratio (4) 25% 37% 15% 71% 72% 72% 72% 74% based 0% Trading Metrics e 2016e 2017e 2018e 2019e 2020e P/E (5) n/a n/a 19.6x 18.7x 18.0x 17.2x 16.4x 15.9x P/CF (5) n/a n/a 8.9x 8.2x 7.9x 7.6x 7.2x 7.1x P/AFFO (2)(5) n/a n/a 16.8x 15.1x 14.5x 14.1x 13.2x 12.9x EV/EBITDA (5) n/a n/a 11.8x 11.6x 11.4x 11.2x 10.9x 10.8x Cost-of-service EV/Free-EBITDA (2)(5) n/a n/a 18.4x 17.9x 17.8x 17.7x 17.1x 16.7x 100% Dividend Yield n/a n/a 0.8% 3.8% 4.0% 4.2% 4.4% 4.6% (1) Includes preferred equity dividends. (2) AFFO = FFO less Maintenance capex; Free-EBITDA = EBITDA less Maintenance capex. (3) Preferred equity treated as 50% debt. (4) FFO payout ratio = Total dividends / FFO; AFFO payout ratio = Total dividends / AFFO; Earnings payout ratio = Total dividends / Net earnings. (5) Based on 12-month trailing figures. Source: Company Reports, NBF Estimates 4-Nov-15 NCI 0% Preferred Equity 2% 5-Nov-15 6-Nov-15 7-Nov-15 8-Nov-15 9-Nov Nov-15 Telecom 0% 11-Nov-15 Transmission 60% Market Capitalization 55% Net Debt 43% 14 PATRICK KENNY

17 Cash flow risk profile With over 99% of Hydro One s cash flows under rate regulation (i.e., cost-of-service) we forecast a group low cash flow risk profile of 1.0 based on a weighted-average calculation of 2016e operating margin multiplied by risk profile, i.e., cost-of-service = 1; fee-for-service = 2; margin-based = 3; and commodity-based = 4. CASH FLOW RISK PROFILE (1) Low RISK High Cost-of-Service Fee-for-Service Margin-Based Commodity- Based Weighted-average Risk Profile High Payout VNR 93% 7% 0% 0% 1.1 VSN 72% 18% 0% 10% 1.5 IPL 58% 37% 0% 5% 1.5 TWM 60% 26% 15% 0% 1.5 ENF 39% 61% 0% 0% 1.6 ALA 34% 62% 0% 5% 1.8 GEI 17% 54% 20% 9% 2.2 KEY 0% 75% 15% 10% 2.3 Average 53% 38% 5% 4% 1.7 Low Payout H 100% 0% 0% 0% 1.0 FTS 96% 4% 0% 0% 1.0 EMA 92% 0% 0% 8% 1.2 CU 83% 12% 0% 5% 1.3 ACO 80% 15% 0% 5% 1.3 ENB 57% 39% 0% 4% 1.5 TRP 59% 33% 0% 8% 1.6 TA 0% 75% 0% 25% 2.5 CPX 0% 52% 0% 48% 3.0 Average 47% 38% 0% 16% 1.6 (1) Represents percentage of 2016e operating margins or earnings. Note: NBF Research restricted on CUS, PPL and SPB. RELATIVE CASH FLOW RISK RANKING Cash Flow Risk Profile Lowest Risk Low Payout: High Payout: Highest Risk Average: H FTS VNR EMA CU ACO VSN ENB IPL TWM TRP ENF ALA GEI KEY TA CPX Note: Based on a weighted average calculation of margins multiplied by risk profile; i.e., cost-of-service = 1, fee-for-service = 2, margin-based = 3 and commodity-based = 4. NBF Research restricted on CUS, PPL, and SPB. PATRICK KENNY 15

18 Capital structure For 2016, we forecast a capital structure of 57% debt, 41% equity and 2% preferred equity versus Ontario s rate-regulated deemed capital structure of 60% debt and 40% equity. As such, we highlight Hydro One s balance sheet capacity for ~$1 billion of incremental debt to align its capital structure with the rate-regulated regime. Meanwhile, with preferred shares representing just 2% of the Company s capital structure versus an estimated 15% maximum under the A credit rating model, we note the potential for Hydro One to issue up to $2.3 billion of preferred shares to partially fund future organic growth and M&A opportunities, reducing the need for additional common equity to partially fund future growth. 2016E CAPITAL STRUCTURE CREDIT RATINGS Equity 41% Preferred Equity 2% Rating agency Rating Outlook DBRS A (high) Under review Moody's A2 Negative S&P A Stable Source: Company Reports Net Debt 57% Liquidity analysis We forecast ample cash available through 2017 of ~$1.8 billion to fully fund its capital expenditure program as well as the retirement of ~$1 billion of debt maturing by mid-2016, while maintaining a D/Cap ratio below 60%. LIQUIDITY ANALYSIS Values in $mlns Q4 2015e 2016e 2017e Adjusted funds from operations Less growth capex Free cash flow (12) Less dividends Free cash flow (net of dividends) (37) (433) (382) Available cash resources Q4 2015e 2016e 2017e Opening cash balance (1) 70 2,583 2,150 Available credit facilities 2,550 n/a n/a Equity + DRIP Preferred equity Free cash flows (net of dividends) (37) (433) (382) Liquidity position 2,583 2,150 1,769 $mlns 7,000 6,000 5,000 4,000 3,000 2,000 1,000 - DEBT MATURITY SCHEDULE 1, , Years to Maturity (1) Debt metrics Target Q4 2015e 2016e 2017e (1) As at June 30, D/Cap (2) <75% 57% 58% 58% Source: Company Reports D/EBITDA (2) n/a 5.1x 5.1x 5.1x FFO/D (2) n/a 15% 15% 15% (1) As at June 30, 2015; net of $200 mln departure tax, $800 mln payment to the Province of Ontario, and $800 mln debt recapitalization. (2) Preferred equity treated as 50% debt. Source: Company Reports 16 PATRICK KENNY