TEXT-S&P raises Plains All American Pipeline ratings
Overview -- U.S. midstream energy company Plains All American Pipeline has grown significantly in size and diversity, and we expect it will maintain strong financial performance with appropriate financial management for the 'BBB' rating. Plains' recent acquisition of BP North America's Canadian natural gas liquids business complements Plains' existing assets and is immediately accretive to cash flow although it modestly increases exposure to commodity prices. -- We are raising Plains' corporate credit rating to 'BBB' with a stable outlook. At the same time, we are raising the issue-level rating on Plains' senior unsecured debt to 'BBB'. -- The stable outlook reflects Plains' increasing size and asset diversity, its fee-based activities that will continue to account for most cash flows, its stable financial performance, and conservative financial policy. Rating Action On May 30, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on Houston-based midstream energy company Plains All American Pipeline L.P. to 'BBB' from 'BBB-'. At the same time, we raised the issue-level rating on Plains' senior unsecured debt to 'BBB'. The outlook is stable. Rationale We base the ratings upgrade on Plains' improved credit profile, resulting from increasing size and asset diversity, its growing fee-based activities, and its strong financial performance. The partnership has steadily increased its scale, geographic footprint, and diversity of its assets through organic capital spending projects and acquisitions that have been closely aligned with its core competencies, and funded in a balanced manner. Plains' financial performance has also improved as a result of advantageous commodity prices and solid volume flows. We expect 2012 debt to EBITDA on an adjusted basis (excluding short-term debt) below 3.5x, continuing its recent strong financial performance. Long-term debt to EBITDA was about 3.6x on a trailing 12-month basis as of March 31, 2012. This ratio excludes Plains' short-term bank debt to the extent short-term hedged inventories cover the borrowing. Including the short-term borrowing, debt to EBITDA was 4.1x as of March 31, 2012. As noted below, we look at both ratios but place less emphasis on Plains' metrics that include short-term debt. However, we also note that the metrics have benefited from robust cash flows in its supply and logistics segment that may not be sustainable. We use more conservative projections for this segment, recognizing its inherent volatility, although a base level of cash flow is assumed based on the partnership's gathering business at more normalized levels. In 2011, the supply and logistics business outperformed and revenues more than doubled to $2.05 per barrel from 90 cents per barrel. This was primarily driven by favorable pricing differentials, as well as other market-related opportunities. We do not assume these market opportunities to be permanent and project that cash flows from this segment will decline in the future. Liquidity remains adequate, with Plains demonstrating its ability to access both the debt and equity markets with sizable issuances of $1.25 billion and $455 million, respectively, in recent months. In addition, recent acquisitions and growth projects complement Plains' existing business, are accretive to cash flow, and offer future expansion opportunities at attractive multiples. The BP acquisition in particular introduces additional commodity exposure. However, we believe it is modest relative to Plains' overall size at less than 10% of cash flow, and that portions of the business, including transportation, storage, and fractionation, could be fee-based if unbundled from the integrated business. The company funded its BP acquisition in a balanced manner by issuing senior unsecured debt totaling $1.25 billion, and simultaneously entering into an equity distribution agreement to raise up to $300 million of equity per year. The partnership also demonstrated a willingness to significantly prefund by raising equity. Standard & Poor's bases its ratings on Plains on a business risk profile we designate as "strong" and a financial risk profile we designate as "significant". The business risk profile reflects the partnership's large and diverse network of pipelines and terminals, which provides stable cash flow, and management's good track record of funding expansion capital projects and acquisitions in a balanced manner. The financial profile reflects the inherent cash flow volatility in its supply and logistics business segment, and the master limited partnership (MLP) structure, which gives Plains incentive to grow through capital expansions and pay out the vast majority of available cash flow to its unitholders each quarter. As an MLP, Plains requires consistent cash flow to meet its targeted distributions. Assuming modest growth in the transportation and facilities segments, more normalized supply and logistics earnings, and a conservative contribution from its acquisitions, we expect Plains to generate about $1.7 billion to $1.8 billion of EBITDA in 2012, with about $300 million in projected interest expense and about $160 million in maintenance capital. As a result, we expect distribution coverage of about 1.3x, which has historically ranged from 1.1x to more than 1.5x. During volatile markets, the marketing division has historically performed well, allowing the partnership to generate stronger-than-expected cash flows that it in turn has reinvested in the business. The company's strengths include: -- Stable cash flows in core transportation and facilities business lines; -- Competitive geographic position, particularly in the PADD II (Midwest region); -- Sizable terminal and storage operations in Cushing, Okla., the delivery point for the New York Mercantile Exchange-traded West Texas Intermediate crude oil; and -- The conservative financial policy has driven debt to EBITDA below 4x while maintaining earnings growth. Weaknesses include: -- A significant amount of profits come from the supply and logistics business, which includes some trading operations that can be volatile; -- Exposure to volume declines in all three segments where revenues generally do not have take-or-pay or cost-of-service provisions; and -- Strong incentives, as an MLP, to distribute essentially all cash after debt service and maintenance capital spending. Plains operates in three broad business segments: transportation (over 40% of our expected 2012 adjusted EBITDA), facilities (about 30%), and supply and logistics (under 30%). Under normalized (or "baseline") market conditions, we expect the stable transportation and facilities segments to generate roughly three-quarters of consolidated EBITDA, noting that this percentage can be significantly lower when the supply and logistics business outperforms. The steady cash flow from the transportation and facilities segments is favorable to Plains' credit profile. In these segments, Plains generates fees for transporting crude oil and refined products through pipelines and gathering systems, and for storage, terminal, and throughput services involving crude oil, refined products, and liquefied petroleum gas (LPG). Plains also includes its small, but growing, natural gas storage business in the facilities segment. The natural gas storage business is housed at PAA Natural Gas Storage L.P., a separate, publicly traded MLP of which Plains is the general partner and owns the majority of the limited partnership units. For year-end 2012, we expect higher volumes in the transportation segment on the Basin and Permian systems, partially offset by lower volumes on the Capline systems. The company has announced a number of growth projects, including expansions in the Mid-Continent, Basin, South Texas, and Bakken regions. The supply and logistics segment, formerly known as marketing, is more volatile, and we typically discount revenue assumptions from unpredictable, arbitrage-driven activities. In this segment, Plains purchases and resells crude oil, stores inventory during contango market conditions (i.e., an upward forward pricing curve), and exchanges crude oil of certain specifications for that of others. Plains leverages its physical infrastructure--including its strategic storage and terminal facilities in Cushing, Okla.--and its many customer and supplier relationships to capitalize on market inefficiencies. This segment tends to perform well during volatile markets, but still generates a base level of cash flow during flat markets, primarily from its crude oil lease-gathering operations. Marketing is a high-volume, low-margin business that entails significant use of derivatives contracts. Therefore, the risks of unforeseen events, such as disruptions in expected crude oil supply or a lapse in personnel's adherence to the company's policies, somewhat weigh on the credit rating. Limitations on open positions and oversight controls appear adequate for managing the risks involved, partially mitigating this concern. The company's policy is to balance its purchases and its sales or future delivery obligations with back-to-back transactions that eliminate price risk, while actively managing counterparty credit risk. Plains' short-term debt primarily relates to hedged crude oil inventory purchases for their contango and waterborne crude programs, and hedged LPG inventory purchases in advance of the heating season. This debt can be volatile from quarter to quarter and is essentially self-liquidating because Plains pays down the debt as it sells the associated hedged volumes. Therefore, we place less emphasis on credit ratios that include short-term debt. However, we do not view the cash flow associated with many of these market-related activities as repeatable and do not assume such cash flows in our forecasts. Liquidity We consider Plains' liquidity to be "adequate" under our corporate liquidity methodology. We expect Plains' sources will exceed uses by at least 1.2x during the next 12 months, although other factors--such as the partnership's recently announced equity distribution agreement with Citigroup to raise up to $300 million of equity per year, its demonstrated ability to raise funding in the capital markets as needed, and its ability to reduce discretionary capital spending in the event of funding disruptions--could improve liquidity further. Pro forma sources of liquidity include funds from operations of about $1.47 billion and revolver availability plus cash of about $1.39 billion. Plains renewed its credit facilities in August 2011 and now has a $1.6 billion committed revolving credit facility maturing in August 2016 and a $450 million committed revolving credit facility at its natural gas storage subsidiary PNG maturing in August 2016. The revolver availability and our sources calculation does not include the $850 million annual committed hedged inventory facility, which will mature in August 2013, and the PNG credit facility. In addition, the company terminated the $500 million 364-day senior unsecured facility that was scheduled to mature in January 2012. Key uses include our assumption of about $1.1 billion in capital spending (including maintenance expenditure but excluding PNG spending) and distributions of about $800 million. As of Mar. 31, 2012, Plains was in compliance with its covenants, and we expect the partnership will remain in compliance through 2012. Outlook The stable outlook on the rating reflects Plains' size and asset diversity, the majority contribution of fee-based activities to Plains' cash flow, and our expectation that management will continue to target leverage below 4x. We also expect that any future acquisitions will not materially change the partnership's key credit ratios or business profile. We could lower the ratings if we expect that the ratio of adjusted long term debt to baseline EBITDA will rise toward 4.5x on a sustained basis or if the partnership makes an acquisition that increases overall cash flow volatility or its business risk. An upgrade is unlikely at this time, but could occur if the partnership increases the proportion of revenue coming from its stable, fee-based pipeline business while mitigating volumes risk and maintaining a conservative financial policy such that we expect debt to EBITDA to remain below 3.5x on a sustained basis. Related Criteria And Research -- Key Credit Factors: Criteria For Rating The Global Midstream Energy Industry, April 18, 2012 -- Standard & Poor's Standardizes Liquidity Descriptors For Global Corporate Issuers, July 2, 2010 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 Ratings List Rating Raised To From Plains All American Pipeline L.P. Corporate Credit Rating BBB/Stable/-- BBB-/Positive/-- Senior Unsecured BBB BBB- PAA Finance Corp. Senior Unsecured BBB BBB- Pacific Energy Finance Corp. Senior Unsecured BBB BBB- Pacific Energy Partners L.P. Senior Unsecured BBB BBB-
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