DBRS Morningstar Downgrades Ratings on Inter Pipeline Ltd. to BBB (low) and BB With Stable Trends, Removes Ratings From Under Review With Developing Implications

DBRS Limited (DBRS Morningstar) downgraded Inter Pipeline Ltd.’s (IPL or the Company) Issuer Rating and Unsecured Medium Term Notes (Senior Notes) rating to BBB (low) from BBB. Concurrently, DBRS Morningstar also downgraded the rating on the Company’s Fixed-to-Floating Rate Subordinated Notes to BB from BB (high). The rating actions remove the ratings from Under Review with Developing Implications. All trends are Stable. The rating downgrade follows the announcement by IPL that as part of the close of the shareholder-approved amalgamation and privatization transaction (the Transaction) initiated by Brookfield Infrastructure Partners L.P. and its institutional partners (together, Brookfield Infrastructure), IPL will assume the acquisition financing debt of $1,425 million (Acquisition Debt) raised by Brookfield Infrastructure. The Acquisition Debt will rank pari passu with IPL’s Senior Notes, and the Transaction is expected to be completed in early November. DBRS Morningstar believes that the assumption of the Acquisition Debt weakens IPL’s financial risk profile. The downgrade in the ratings also factors in the increase in the project cost and delay in commissioning at the Heartland Petrochemical Complex (HPC) announced by IPL in August 2021. The Stable trend reflects DBRS Morningstar’s expectation that once the HPC is fully operational, the Company’s credit metrics will improve and that Brookfield Infrastructure will maintain IPL’s credit metrics at a level commensurate with the current rating.

Previously, DBRS Morningstar had expected 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 (last 12 months (LTM) Q2 2021: 15.5%) to improve to above 20% once the HPC was placed in service in 2022. However, as a result of the assumption of the Acquisition Debt, DBRS Morningstar expects the improvement in the modified consolidated cash flow-to-debt ratio (pro forma Acquisition Debt LTM Q2 2021: 12.1%) to be limited to 15% to 17%. In addition, the improvement in the credit metrics is expected to be deferred to 2023 because the HPC is expected to have a staggered start-up schedule, with the polypropylene (PP) facility expected to commence operations in Q2 2022 and the propane dehydrogenation facility (PDH) facility closely thereafter. (Previously the PP and PDH facilities were scheduled to commence operations in early 2022.)

IPL’s strong business risk profile remains unaffected by the Transaction and is underpinned by earnings generated under cost-of-service (COS), take-or-pay (ToP), and fee-based contracts with primarily investment-grade counterparties. IPL has secured ToP contracts for approximately 70% of the HPC's production capacity with a weighted-average term of approximately nine years. Based on existing contracts, DBRS Morningstar expects that once the HPC is fully operational, long-term COS/ToP contracts and fee-based contracts will generate approximately 65% and 15% of the Company’s EBITDA, respectively.

The key challenge to the rating remains the construction and commissioning risk at the HPC. In August 2021, IPL announced a $100 million increase in the budgeted cost for the HPC to $4.3 billion and a staggered start-up schedule, as noted earlier. DBRS Morningstar notes that to successfully ramp up production and improve key credit metrics, the Company will have to manage operational risks associated with the start-up of a large petrochemical plant. DBRS Morningstar notes that the project is almost 90% complete, and, given IPL’s modest capital expenditure (capex) in 2022 and the improved outlook for commodity prices, the Company is expected to generate a material free cash flow (cashflow after capex) surplus, which should provide it with the flexibility to fund any unforeseen increase in the project cost at the HPC without a material increase in debt.

DBRS Morningstar expects IPL’s earnings to benefit from the improved outlook for commodity prices. As a result, DBRS Morningstar expects IPL's EBITDA in 2021 to be higher compared with 2020 because higher earnings from the conventional pipeline and marketing businesses more than offset the impact of the sale of a portion of the European bulk liquid storage business. However, DBRS Morningstar expects the Company’s financial risk profile to remain under pressure in 2021 because of the anticipated increase in debt with the modified consolidated cash flow-to-debt ratio at around 12%. DBRS Morningstar expects the credit metrics to improve in 2022 once the HPC is commissioned and expects IPL to maintain its modified consolidated cash flow-to-debt ratio in excess of 15% once the HPC is fully operational. DBRS Morningstar expects Brookfield Infrastructure to manage financial leverage at IPL to maintain the key credit metrics at a level commensurate with the rating. DBRS Morningstar views IPL’s liquidity to be sufficient, with approximately $2.0 billion available under its credit facilities at Q2 2021 and manageable debt maturities over the next 12 months. DBRS Morningstar notes that IPL is a significant and strategic investment for Brookfield Infrastructure, and while not anticipated, it could provide additional liquidity support to IPL if required.

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 the HPC is fully operational and the credit metrics improve materially.

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 Pipeline and Diversified Energy Industry (November 19, 2020; https://www.dbrsmorningstar.com/research/370267); Rating Companies in the Oil and Gas and Oilfield Services Industries (August 16, 2021; https://www.dbrsmorningstar.com/research/383104); and DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (October 21, 2021; https://www.dbrsmorningstar.com/research/386355). 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).

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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