TEXT-S&P rates Regency Energy $500 mln notes 'BB'
Overview -- U.S. midstream energy partnership Regency Energy Partners L.P. (BB/Stable/--) intends to issue $500 million of senior unsecured notes. -- We are assigning our 'BB' rating to the notes, proceeds of which the partnership will use to repay borrowings outstanding on its revolving credit facility. -- We base the stable rating outlook on our view that the partnership's larger cash flow contribution from its pipeline joint-venture interests should continue to lower financial leverage through 2012. Rating Action On Sept. 27, 2012, Standard & Poor's Ratings Services assigned its 'BB' senior unsecured rating and '4' recovery rating on U.S. midstream energy partnership Regency Energy Partners L.P.'s and Regency Energy Finance Corp.'s issuance of $500 million senior unsecured notes. The partnership will use proceeds from the notes to repay borrowings outstanding on its revolving credit facility. The outlook is stable. Rationale Standard & Poor's ratings on U.S. midstream energy partnership Regency reflect its "fair" business risk profile and "aggressive" financial risk profile under our criteria. Some commodity price sensitivity, a small, but growing, asset base, and a diversified business mix with a large fee-based cash flow component characterize the partnership's fair business risk profile. Moderate financial leverage, an aggressive growth strategy, and the master limited partnership (MLP) structure result in an aggressive financial profile, in our view. Energy Transfer Equity L.P. owns the 2% general partner and 15% limited partner interest in Regency. Regency's aggressive financial risk profile reflects our expectation for financial leverage in the mid-4x area (partnership debt to EBITDA plus joint-venture distributions), a significant capital spending program, and weak distribution coverage at just under 1x in 2012. Under our base-case forecast, we assume a modest cash flow decline in the transportation segment related to lower throughput (about 5%) on the Regency Intrastate Gas System (RIGS), a growing cash flow contribution from the gathering and processing and Natural Gas Liquids (NGL) Logistics segment, relatively flat cash flows from the contract services segment, and used Standard & Poor's NGL price deck for unhedged NGL prices. We forecast Regency will generate between $450 million and $475 million of EBITDA and have about $2.2 billion of total debt by year-end 2012. We expect the partnership's distribution coverage to be weak at about 1x, given the cash flow lag from organic projects. We include 100% of Regency's convertible preferred equity as debt in our calculations because it does not receive equity credit under our hybrid security criteria. Our financial ratios also treat the interests in the pipeline assets and Lone Star joint venture on an unconsolidated basis; i.e., we do not include the debt and only consider the upstream dividends in EBITDA. If we were to proportionately consolidate the debt and the cash flow at the joint ventures, we would expect debt to EBITDA of about 5.25x in 2012. Regency's gathering and processing business accounts for just under 40% of total margin and carries the most risk in our view, because a portion of the cash flows fluctuate with changes in commodity prices. The partnership typically hedges a meaningful percentage of this risk in the near term, and the percentage hedged declines over 24 months. Regency processes most of its gas under fee-based and percentage-of-proceeds contracts, although it does have some keep-whole contracts in the Mid-Continent and West Texas regions. Volumetric risk exists in the gathering businesses when commodity prices are low. Producers could slow drilling, which would curtail cash flows. We estimate that about 8% of Regency's 2012 segment margin is subject to changes in commodity prices. When excluding hedging, this percentage increases to about 20%. We view Regency's joint-venture interests in RIGS and Midcontinent Express Pipeline LLC (MEP), which accounts for about 30% of gross margin, favorably due to the very stable cash flow stream that long-term, firm "take-or-pay" demand contracts generate. The structure of these shipper contracts makes the pipeline's cash flows immune to changes in throughput. The RIGS joint venture and MEP ownership interest enhance Regency's business risk profile by adding geographic and asset diversity to the partnership's portfolio. However, we view the average shippers' credit quality of 'BB' on RIGS and MEP as somewhat weak, which partially offsets the assets' strengths. In addition, Regency creditors only benefit from upstream dividends from these assets. There is substantial debt at MEP (see the research update on MEP, published July 30, 2012). We believe ETP-Regency Midstream Holdings LLC, the joint venture which owns the LDH Energy Asset Holdings LLC (LDH) assets, will reinvest most of the net cash flow generated from the LDH assets into organic growth projects rather than distribute it to the partnerships in 2012. We estimate that Regency's 30% interest in the Lone Star joint venture could account for about 10% of total margin but about 50% of growth capital (Regency estimates its total growth capital spending will be about $800 million in 2012). The growth projects, such as the West Texas gateway pipeline and additional fractionation capacity, get support from fee-based, long-term contracts. We view the contract services business as supportive of credit because its fee-based cash flow has been fairly resilient even when rig counts decline. This segment, which we estimate accounts for 25% of total margin, provides compression and treating services to oil and gas producers and gives Regency some business and geographic diversity into the emerging shale plays. Liquidity We consider Regency's liquidity to be "adequate" under our corporate liquidity methodology. We have assumed sources of liquidity divided by uses of about 1.2x during the next 12 months. Primary sources of liquidity include our assumptions for funds from operations of $375 million and revolving credit facility availability of $635 million. Regency upsized its revolving credit facility due June 15, 2014 to $1.15 billion effective Sept. 6, 2012. We have assumed that Regency's main uses of cash for the next 12 months will include maintenance and growth capital spending of about $800 million and distributions of about $320 million. A key assumption underlying our assessment of Regency's liquidity is that we would expect the partnership to scale back its discretionary capital spending and/or distributions if it couldn't generate or obtain sufficient funding to support its growth plans. Regency has no near-term debt maturities. The revolving credit facility requires Regency to maintain a total debt to EBITDA ratio below 5.25x, senior debt to EBITDA below 3x, and EBITDA interest coverage above 2.75x, with adjustments for material projects and joint ventures. As of June 30, 2012, the partnership was in compliance with these covenants, with an EBITDA cushion of about 30% for the total leverage covenant. EBITDA includes pro forma credit for recently completed projects. Recovery analysis The rating on Regency's unsecured debt is 'BB' (the same as the corporate credit rating) and the recovery rating on this unsecured debt is '4', indicating our expectation that lenders would receive average (30% to 50%) recovery if a payment default occurs. For the full recovery analysis, see the recovery report on Regency published June 4, 2012. Outlook The stable rating outlook reflects our view that the partnership's larger cash flow contribution from its pipeline joint-venture interests should continue to lower financial leverage through 2012. In our opinion, higher ratings are possible over the longer term if Regency maintains total adjusted debt to EBITDA at or below 4x (partnership debt to EBITDA plus joint-venture distributions), and increases the cash flow it receives not only from its stable pipeline joint-venture interests but also from fee-based organic projects at the partnership level. We could lower the rating if the partnership's cash financial leverage approaches 4.75x and we do not see a clear path for improvement. Related Criteria And Research -- Standard & Poor's Revises Its Natural Gas Liquids Price Assumptions For 2012, 2013, And 2014, June 11, 2012 -- Key Credit Factors: Criteria For Rating The Global Midstream Energy Industry, April 18, 2012 Ratings List Regency Energy Partners L.P. Corp. credit rating BB/Stable/-- New Ratings Regency Energy Partners L.P. Regency Energy Finance Corp. $500 mil. senior unsecured notes BB Recovery rating 4
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