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

DBRS Limited (DBRS Morningstar) confirmed the ratings on Inter Pipeline Ltd. (IPL or the Company) at BBB and BB (high). All trends are Stable. The rating confirmations reflect the Company’s strong business risk profile underpinned by (1) contracted cost-of-service (COS) and fee-based contracts, (2) diversified asset base, and (3) significant progress made by the Company in securing long-term contracts for available capacity at the Heartland Petrochemical Complex (HPC or the Project). The key challenge to the rating remains project execution risk (significantly reduced since the last review in May 2020) and operational risk at HPC. DBRS Morningstar notes that Brookfield Infrastructure Partners L.P., together with its institutional partners, has made an unsolicited offer to acquire all outstanding common shares of IPL. Given the uncertainty associated with the final outcome of this unsolicited offer, DBRS Morningstar did not factor the offer into IPL’s rating confirmations.

IPL has secured take-or-pay (ToP) contracts with seven counterparties for approximately 60% of HPC's production capacity with a weighted-average term of approximately nine years. The Company has also received a cash grant of $408 million under the Alberta Petrochemicals Incentive Program (APIP) to be paid over three years once HPC is placed in service. IPL expects existing ToP contracts and the APIP grant together to account for approximately 70% of IPL’s forecast EBITDA at HPC ($400 to $450 million) in 2023, the first full year of operations. Furthermore, approximately 85% of forecasted HPC ToP EBITDA will be generated from investment-grade counterparties. The Company is currently in negotiations with additional counterparties and, if concluded successfully, IPL anticipates to exceed its minimum target of 70% of HPC's capacity to be secured under third-party ToP contracts prior to the in-service date. DBRS Morningstar believes the existing ToP contracts and the APIP grant significantly reduces the uncertainty associated with the extent of commodity price exposure at HPC. When HPC is fully operational, DBRS Morningstar expects approximately 80% of IPL's consolidated EBITDA to be generated under existing COS, ToP, and fee-for-service contracts with third parties.

IPL also recently announced a $200 million increase in the budgeted cost at HPC to $4.2 billion in part due to additional expenses associated with keeping workers safe through the Coronavirus Disease (COVID-19) pandemic. DBRS Morningstar does not expect the cost increase to have a material impact on the Company's ability to deleverage in 2022 as construction progresses on schedule. DBRS Morningstar notes that to successfully ramp up production and deleverage the Company will have to manage operational risks associated with the start-up of a large petrochemical plant.

Earnings at IPL's transportation segment in 2020 remained relatively stable through the coronavirus pandemic, with weakness in the conventional pipelines business partially offset by stronger earnings at the bulk liquid storage business. However, lower commodity prices did have a negative impact on earnings at IPL's marketing segment, resulting in a reduction in overall EBITDA. In order to preserve balance sheet strength, IPL reduced its dividends (72%) and discretionary capital expenditure (capex). While ongoing growth capex at HPC resulted in the Company generating a material free cash flow (FCF: cashflow after capex and dividends) deficit, debt levels at YE2020 remained relatively unchanged compared with YE2019 as the Company used net proceeds (approximately $654.2 million) from the sale of a portion of its European bulk liquid storage business to fund the deficit. IPL’s key credit metrics in 2020 were in line with DBRS Morningstar’s expectations.

DBRS Morningstar expects IPL to benefit from the improved outlook for commodity prices. However, DBRS Morningstar expects only a modest increase in IPL's EBITDA in 2021 as higher earnings from the conventional pipeline and marketing businesses are offset by the impact of the sale of a portion of the European bulk liquid storage business. DBRS Morningstar expects the Company’s financial risk profile to remain under pressure in 2021 because of an anticipated increase in debt ($0.5 billion to $0.6 billion) as IPL incurs capex on the Project and receives no incremental cash flow during construction.

DBRS Morningstar expects IPL’s modified consolidated (treating Inter Pipeline (Corridor) Inc., rated A (low) with a Stable trend by DBRS Morningstar, as an equity investment) cash flow-to-debt ratio to be around 14% and its modified consolidated debt-to-capital ratio to be in the 50% to 55% range in 2021. Given IPL's reduced dividend and modest sustaining capex requirements, DBRS Morningstar expects the Company to generate a material FCF surplus in 2022 when IPL places HPC in service. DBRS Morningstar expects the Company to direct the surplus to reduce debt. Consequently, DBRS Morningstar expects the Company’s modified consolidated cash flow-to-debt ratio will improve materially in 2022 to around 20%. DBRS Morningstar notes that sale of a material stake at HPC could accelerate deleveraging and reduce IPL’s exposure to the petrochemical business, which DBRS Morningstar deems to be riskier than the Company’s core pipeline transportation business. DBRS Morningstar views IPL’s liquidity to be sufficient with approximately $2.3 billion available under its credit facilities at Q1 2021 and manageable debt maturities over the next 12 months.

DBRS Morningstar may consider a negative rating action if credit metrics weaken materially below DBRS Morningstar's expectation and/or IPL's business risk profile deteriorates materially. A positive rating action is unlikely until HPC is fully operational and IPL exceeds its minimum contracting targets at HPC and the credit metrics improve in line with DBRS Morningstar's expectations.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodologies are Rating Companies in the Oil and Gas and Oilfield Services Industries (August 17, 2020; https://www.dbrsmorningstar.com/research/365808), Rating Companies in the Pipeline and Diversified Energy Industry (November 19, 2020; https://www.dbrsmorningstar.com/research/370267), DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2, 2020; https://www.dbrsmorningstar.com/research/369167), and DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 2, 2020; https://www.dbrsmorningstar.com/research/369165). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

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.

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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