NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB-' rating to Kinder Morgan Inc.'s (KMI) proposed senior notes issuance. The notes are expected to be used to pay the cash portion of the merger consideration for the acquisition of Kinder Morgan Energy Partners, LP (KMP)and El Paso Pipeline Partners, LP (EPB), related fees and expenses of the transactions, and indebtedness outstanding under KMI's and KMP's existing credit agreements.
On Aug. 11, 2014, KMI announced that it will acquire all of the outstanding equity securities of KMP; Kinder Morgan Management, LLC; and El Paso Pipeline Partners, L.P. (EPB) in a transaction valued at over $71 billion. The deal effectively rolls KMI's partnership subsidiaries into a more traditional taxpaying corporate structure. The mergers have received all required regulatory approvals and unit-holders' votes and are scheduled to close Nov. 26, 2014.
Fitch uses a consolidated ratings approach for KMI and its various subsidiaries based on cross guarantees among and between the Kinder Morgan companies that create a single creditor class and virtually eliminates structural subordination. The cross guarantees are absolute and unconditional between the entities. The roll-up of entities into one single creditor class simplifies KMI's corporate structure and provides meaningful benefits to KMI's credit profile. In particular, it does away with nearly all of the structural subordination that limited KMI's ratings to a notching below its operating subsidiaries and relieves the burden KMP's and EPB's incentive distributions rights put on their ability to grow.
Fitch believes that the combined entities will continue to be one of the largest and most important energy companies in the U.S., with significant positions in must-run assets that support national energy infrastructure. KMI's size and scale should continue to provide economies of scale and favorable capital market access. The ratings are supported by significant cash flow stability, with over 90% of current year cash flows fee-based or hedged and expectations that KMI's high percentage of fixed fee generating assets will minimize earnings and cash flow volatility. Leverage at the consolidated entity will be high, with a targeted range of between 5.0x to 5.5x debt/EBITDA on a sustained basis. However, KMI's asset size, scale, and cash flow profile are unique and much more indicative of an investment-grade profile, offsetting concerns around the high leverage targets.
KEY RATINGS DRIVERS
Simplified Structure/Structural Equivalence: The roll-up of entities into one single creditor class simplifies the corporate structure and provides benefits to KMI's credit profile, in particular, by nearly eliminating the structural subordination that limited KMI's ratings to a notching below its operating subsidiaries. All of the operating cash flow of the entities would be available to KMI to fund operations, reduce debt and or pay dividends, which helps to alleviate structural subordination at KMI. Dividends would be targeted at a 10% growth rate and the company would be able to retain excess cash to help fund part of its growth capital program, which was not practically possible at its MLPs given the increasing pressure to meet incentive distributions particularly at KMP which has long been in its 50/50 splits.
Strong Asset Profile: The combined entity will continue be one of the largest and most important energy companies in the U.S. with significant positions in 'must-run' assets that support national energy infrastructure. KMI as a combined entity is currently the largest independent transporter of petroleum products in the nation and the largest transporter of natural gas. Its asset base touches all of the major supply and demand areas for oil, oil products, NGLs and natural gas in the country. The combined entity is expected to have an enterprise value in excess of $130B and approximately $8B in EBITDA.
High Leverage Targets: Leverage at the consolidated entity is expected to be high with a targeted range of between 5.0x to 5.5x debt/EBITDA on a sustained basis. Relative to 'BBB-' rated midstream entities, leverage (absent any consideration for size scale and asset quality) in the 5.0x to 5.5x debt/EBITDA range and EBITDA interest coverage in the 3.0x to 4.0x is more consistent with a sub-investment grade rating. However, KMI's asset size, scale and cash flow profile is unique and much more reflective of a higher investment grade profile given the cash flow stability and general size/importance, offsetting concerns around the high leverage targets. Fitch expects that a combined KMI as the largest midstream company and third largest energy company in the country would have significant operational advantages and capital market access advantages and more than adequate liquidity.
Guarantees Warrant Consolidated Approach: The cross guarantees are absolute and unconditional between the entities and any refinancing of maturing notes is expected to be done primarily at the KMI level over time (excepting some pipeline debt which would remain at the pipelines for rate-making purposes but remain cross guaranteed). The consolidated rating reflects the near removal of the structural subordination as well as the strong cash flow and operating diversity of its asset base, for the previously higher rated entities the rating is reflective of the cross guarantees coupled with the high leverage reflecting what in most cases is a somewhat weaker credit profile than KMP and the majority of the pipelines were rated absent the explicit cross guarantees.
Adequate Cash Flow Generation: KMI is expected to generate approximately $4.8 billion in free cash flow before dividends and growth capital expenditures in 2015 growing to over $7.0B in FCF before dividends and growth capex in 2019 and retain a 1.1x dividend coverage ratio for the next five years even with a 10% growth rate on dividends paid out to shareholders. As mentioned all of the operating cash flow of the entities would be available to KMI to fund operations, reduce debt and or pay dividends, this helps to alleviate structural subordination at KMI. Over 90% of current year consolidated cash flows are fee-based or hedged, providing comfort around cash flow and earnings stability. Fitch expects the consolidated entity to target a high percentage of fixed fee or hedged revenue consistent with current and historical practices.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
--A meaningful reduction in leverage, with debt/adjusted EBITDA between 4.5x - 5.0x on a sustained basis.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--A significant change in cash flow stability profile or current hedging practices. A move away from current significant majority of assets being fee based or hedged could lead to a negative ratings action.
--Failure to manage leverage to the stated 5.0x to 5.5x on a sustained basis. Fitch notes that leverage in near term will be slightly above 5.5x as several large scale construction projects get built but metrics are expected to be below 6.0x and are expected to improve to the target range as projects are completed.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'MLP End Game: Common Goals - Divergent Strategies' (November 2014);
--'Bakken Shale Report: Prolific Oil Production Prompts New Pipelines' (October 2014);
--'What Investors Want to Know: Pipelines, Midstream and MLPs' (October 2014);
--'Pipelines, Midstream and MLP Stats Quarterly - Second Quarter 2014' (September 2014);
--'Midstream Spending Significantly Rising for MLPs and C-Corps' (August 2014);
--'Liquidity Review: Pipelines, Midstream and MLPs' (July 2014);
--'U.S. Midstream Dashboard' (June 2014);
--'Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 2014);
--'Rating Pipelines, Midstream and MLPs - Sector Credit Factors' (January 2014).