DBRS Morningstar Confirms Ratings on Inter Pipeline Ltd. at BBB and BB (high), Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and the Unsecured Medium Term Notes rating of Inter Pipeline Ltd. (IPL or the Company) at BBB. DBRS Morningstar also confirmed the rating on IPL’s Fixed-to-Floating Rate Subordinated Notes at BB (high). All trends are Stable.

The rating confirmations reflect the Company’s strong business risk profile underpinned by contracted revenues—primarily with investment-grade counterparties (80% at FY2019)—at its oil sands transportation, conventional pipelines, and bulk liquid storage businesses (collectively, the Contracted Business). Cost-of-service (COS) and fee-based contracts accounted for 72% and 18%, respectively, of the Company’s EBITDA for the three months ended March 31, 2020. The rating confirmations also reflect DBRS Morningstar’s expectation that key credit metrics will improve materially in 2022 when IPL places the Heartland Petrochemical Complex (HPC or the Project) in service after factoring in the startup delay to early 2022 and the $500.0 million increase in Project costs.

The Stable trends reflect DBRS Morningstar’s expectation that the Contracted Business will continue to generate cash flow comparable with 2019 over the next two years, despite near-term weakness in the conventional pipelines business. The Stable trends also acknowledge the Company’s prudent steps to respond to the current downcycle, such as reducing its dividend by 72%, reducing operating costs and discretionary capital expenditure (capex), adding liquidity of $1.0 billion, and exploring the proposed sale of a material interest in HPC (see DBRS Morningstar’s April 3, 2020, press release). DBRS Morningstar believes that IPL’s decision to reduce its dividend will allow it to materially deleverage its balance sheet in 2022 and beyond, even if realized EBITDA from HPC is below the Company’s guidance of $450 million to $500 million. DBRS Morningstar also considers IPL’s decision to explore selling a material stake at HPC to be a positive development. While timing is uncertain, if successful, the stake sale could accelerate deleveraging ahead of 2022 and improve the Company’s business risk profile as it will reduce IPL’s exposure to petrochemical business, which DBRS Morningstar deems to be riskier than the Company’s Contracted Business.

The Coronavirus Disease (COVID-19) has led to a sudden and drastic drop in energy demand, resulting in a steep decline in commodity prices. DBRS Morningstar expects the negative financial impact of lower commodity prices on Contracted Business to be modest and limited to the conventional pipeline businesses, especially in 2020 as oil and gas producers in Western Canada curtail production. However, DBRS Morningstar expects stronger earnings at IPL’s bulk liquid storage business from high levels of contango (i.e., the forward product price is higher than the spot price) in crude oil and petroleum product markets to partially offset this impact. DBRS Morningstar believes that the extreme volatility in markets is subsiding and expects crude oil prices to reach the lower end of its midcycle pricing forecast of USD 50 to USD 60 per barrel for West Texas Intermediate crude oil by 2022 (see DBRS Morningstar’s May 15, 2020, commentary entitled “As Coronavirus Lockdowns Ease, DBRS Morningstar Resets Outlook for Oil and Natural Gas Prices”). Higher crude oil prices coupled with new assets placed in service in mid-2020 should result in higher earnings from the conventional pipeline business in 2021 and 2022. DBRS Morningstar expects IPL’s natural gas liquids (NGL) processing business to be the hardest hit because of its exposure to commodity and volume risk. DBRS Morningstar anticipates that earnings from the Company’s NGL processing business in 2020 will be materially lower and, while improving over the next two years, DBRS Morningstar does not expect it to return to 2019 levels before 2022.

The budgeted cost at HPC has increased by $500.0 million (the majority of which IPL expects to incur in 2021 and 2022) and the in-service date has also been delayed to early 2022 from late 2021. Design and construction costs have only increased by $100.0 million while the rest of the cost increase relates to startup and commissioning ($170.0 million), coronavirus impact ($150.0 million), and higher interest during construction ($80.0 million). Precautionary measures implemented to prevent a coronavirus outbreak at the Project site have resulted in a projected delay to the in-service date. DBRS Morningstar notes that the Company has maintained its long-term average annual EBITDA guidance and target contract levels of 70% to 85% of processing capacity at HPC.

DBRS Morningstar expects the Company’s financial risk profile to remain under pressure through 2021 because of an anticipated increase in debt ($0.9 billion to $1.0 billion) as IPL incurs capex on the Project and receives no incremental cash flow during construction. DBRS Morningstar expects IPL’s nonconsolidated cash flow-to-debt ratio to be around 13% to 15% and its nonconsolidated debt-to-capital ratio to be in the 50% to 55% range through the HPC construction period. DBRS Morningstar projects that the Company’s nonconsolidated cash flow-to-debt ratio will improve materially (more than 20%) in 2022 when IPL places HPC in service. DBRS Morningstar views IPL’s liquidity profile to be sufficient with $2.2 billion available under its credit facilities at April 24, 2020.

Overall, DBRS Morningstar believes that despite its weaker financial profile, IPL’s business risk profile remains sufficiently strong to support the current rating. DBRS Morningstar may consider a negative rating action if (1) EBITDA and contract levels at HPC are materially below expectations; (2) credit metrics are weaker than expected because of materially higher debt levels related to further cost escalations or delays at HPC without any mitigation; or (3) IPL’s business risk profile weakens as persistent lower oil prices lead to higher counterparty risk and weaker supply demand fundamentals.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodologies are Rating Companies in the Pipeline and Diversified Energy Industry (November 26, 2019), Rating Companies in the Oil and Gas and Oilfield Services Industries (August 23, 2019), DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019), and DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 1, 2019), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

DBRS Morningstar will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrsmorningstar.com.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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