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Peer Comparison: 'BBB' Rated Midstream Companies Are Energized

The midstream energy industry has expanded significantly as an asset class since its beginnings in 1981 with the creation of the master limited partnership and pass-through investment structures. The industry has evolved from high-growth entities that distribute all their cash flow to a slower-growth profile focused on positive free cash flow for future investment.

Gone are the days of distributing all remaining cash flow after interest expense and maintenance capital spending, when entities depended on the debt and equity capital markets to fuel growth of distributions to shareholders. Some of the largest diversified energy companies are paving the way to provide energy solutions for North America over the long term. At times, we field investor questions on a comparative analysis among our largest and highest-rated midstream companies. What follows are our insights into the similarities and differences of four of the largest midstream companies in the mid to upper 'BBB' category: TC Energy Corp., Enbridge Inc., Kinder Morgan Inc., and Enterprise Products Partners L.P.

Table 1

Peer Ratings Score Snapshot Comparison

Enbridge Inc.

TC Energy Corp.

Enterprise Products Partners L.P.

Kinder Morgan Inc.

Foreign currency rating BBB+ BBB+ BBB+ BBB
Country risk Very low Very low Very low Very low
Business risk profile Excellent Excellent Strong Excellent
Industry risk Intermediate Intermediate Intermediate Intermediate
Competitive position Excellent Excellent Strong Excellent
Financial risk profile Significant Significant Significant Aggressive
Anchor a- a- bbb bbb
Modifiers
Diversification/portfolio effect Neutral Neutral Neutral Neutral
Capital structure Neutral Neutral Neutral Neutral
Financial policy Neutral Neutral Neutral Neutral
Liquidity Adequate Adequate Adequate Adequate
Management and governance Satisfactory Satisfactory Strong Satisfactory
Comparable rating analysis Negative Negative Positive Neutral
Stand-alone credit profile bbb+ bbb+ bbb+ bbb

Critical Infrastructure To Support North America's Energy Needs

Enbridge is the largest, making it an integral transporter of hydrocarbons. It transports approximately 25% of produced crude oil in North America and 20% of the natural gas consumed in the U.S. With its integrated pipeline system, TC Energy transports 20% of Western Canadian Sedimentary Basin exports and 25% of natural gas demand across North America. Although Kinder is the smallest of the peer group (Chart 1), it has the largest natural gas transmission network, allowing it to transport approximately 40% of U.S. natural gas consumption and exports. It is also the largest independent transporter of refined products. Enterprise does not have as large of a natural gas pipeline network, but it is the world's largest exporter of liquefied petroleum gas with a firm competitive position in the Houston Ship Channel.

Chart 1

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Our view of the regulatory environment could either strengthen or weaken our assessment of a midstream energy company's business risk profile. We consider the Canada Energy Regulator very supportive of Canada's energy infrastructure compared to that of the U.S. These four entities have excellent business risk profiles except for Enterprise with strong, reflecting its above-average scale, diversity, and cash flow stability. They also benefit from strong customer credit quality, which is largely investment-grade. Enterprise's profile reflects a higher percentage of commodity price exposure than the peer group; 87% of the partnership's gross operating margin is fee-based whereas these peers have at least 95% fee-based. Most of its commodity price exposure is tied to certain natural gas processing and gathering and natural gas liquid fractionation contracts, which could lower margins when commodity prices decline.

While we have no separate categories within the excellent business risk profile, we believe TC Energy's and Enbridge's asset mixes support an assessment at the higher end of the range. For Enbridge, this largely reflects the robust contract profile, including its utility operations (almost 15% of EBITDA) and utility-like demand-pull assets. For TC Energy, its contract profile is approximately 95% contracted or cost of service, Enbridge is 98% contracted cost of service or competitive tolling settlement, and Kinder is 68% take-or-pay with 25% fee-based, which tends to have some measure of cash flow stability (Charts 3-6).

Kinder's refined product pipeline system tends to have sticky volumetric levels and cash flows. This business underperformed in 2020 because of the COVID-19 pandemic, when refined product demand was muted because of regional lockdown orders and social distancing efforts. Of the four, we view Kinder's CO2 business to be the riskiest business segment but recognize that its gathering and processing business is also exposed to volumetric risk and higher cash flow volatility, both directly and indirectly during commodity price volatility. Combined, these businesses make up almost 20% of EBITDA, and the CO2 business makes up approximately half of that. We consider the CO2 operations Kinder's riskiest because of its direct exposure to commodity prices. That said, the company has operated a well-disciplined hedging policy that mitigates near-term price volatility. It has consistently scaled back operations during commodity price downturns accordingly. In addition, its low-cash cost structure has allowed it to generate positive margins and high returns through multiple commodity price cycles. We believe this segment could provide additional growth opportunities as carbon-capture opportunities become accretive.

Chart 2

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Chart 3

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Chart 4

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Chart 5

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Chart 6

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Canadian Midstream Energy Companies Operate With Higher Leverage

Having extensive multiyear capital spending budgets has resulted in both Enbridge and TC Energy historically operating with materially higher adjusted leverage than U.S. peers. While Enbridge has reduced its adjusted debt to EBITDA following the sale of its riskier business segments, its leverage remains higher than these peers. Construction on Enbridge's Line 3 is now complete in the U.S. It will reduce the company's adjusted leverage in 2022 and beyond. Now that TC Energy has terminated the Keystone XL project, we revised our leverage expectations and no longer expect it to remain as elevated in the near term. We expect adjusted leverage to be approximately 4.9x and its funds from operations (FFO)-to-debt ratio in the 14%-15% range. We expect Kinder Morgan's financial leverage to be in the low- to mid-4x area this year because of the one-time effects of the February winter storm, but roughly in line with these Canadian peers next year.

Enterprise historically has managed its business with lower leverage than the peer group, and we expect that to continue. Its target leverage ratio of approximately 3.5x is materially lower than the peer group leverage, which allows us to rate the partnership in line with its larger peers. Kinder Morgan's financial risk profile assessment is a category below these Canadian peers' because we factor in its FFO-to-debt ratio, which is often used for companies with strong regulatory frameworks, such as regulated utilities.

Chart 7

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Significant Backlog Of Capital Projects For Canadian Entities

As some of the largest midstream energy companies across North America, these four have spent billions of dollars to meet the infrastructure needs across the region. Despite shifts in energy supply and demand dynamics, the peer group has identified over $38 billion in capital projects, most of which is getting Canadian hydrocarbons to end markets. TC Energy has the largest capital backlog, making up almost half of the identified amount at approximately $20.9 billion (down from approximately $37.2 billion when Keystone XL was included). We now forecast construction costs related to its gas pipes across North America to make up three-quarters of that total, most of which will be building out infrastructure in Canada. We now believe U.S. peers have fewer capital spending opportunities than TC Energy and Enbridge:

  • Enbridge has successfully placed over $30 billion of capital projects in operation since 2016 and expect $10 billion this year, most of which will support further growth in its liquids and gas business (Chart 8).
  • Kinder has only publicly disclosed $1.3 billion in capital projects (Chart 9), but we expect it likely will have similar spending to Enterprise, which has identified almost $3.4 billion of projects through 2023. Like its peers, Kinder is focusing on low carbon initiatives, recently announcing a $310 million acquisition that will accelerate its entry into the renewable natural gas market. In addition, over 60% of its capital backlog is earmarked for natural gas projects.
  • The U.S. is a low-cost supplier of petrochemical feedstocks and olefins, allowing Enterprise to focus almost 75% of its capital spending program on its petrochemicals and refined products business (Chart 10). Of the peer group, Enterprise focuses less capital spending on pipeline projects.
  • With both TC Energy (Chart 11) and Enbridge expanding their renewable power portfolios, we believe their U.S. peers will pursue these if accretive. That said, typical growth opportunities in the midstream sector have declined. As discretionary cash flow generation increases, it will likely lead to further industry consolidation.

Chart 8

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Chart 9

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Chart 10

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Chart 11

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Canadian Midstream Energy Companies Rely On Hybrid Securities

U.S. midstream energy companies typically have plain vanilla capital structures and do not rely heavily on complex securities such as hybrids. They tend to use these securities when equity markets are closed or when it is challenging to obtain financing. The preferred equity market in Canada is more mature than the one in the U.S. As a result, it has a deeper investor base. This has supported both TC Energy's and Enbridge's capital programs over the last decade. Both rely more heavily on hybrid securities. Hybrid capital instruments constitute over 15% of TC Energy's capital structure. When more than 15% of capitalization consists of hybrids, and we anticipate this will continue, we generally classify all hybrid amounts over that threshold as debt (no equity content). As a result, we likely would treat any further hybrid securities issuances by TC Energy as debt absent any increase in its capitalization until this ratio improves below 15%, which is likely over the near term. Though Enbridge continues to have excess capacity to issue further hybrid securities, its cushion is lower than those of Kinder and Enterprise (Chart 12). Most of Enterprise's hybrid securities are junior subordinated notes, which receive 50% equity treatment in our leverage calculations.

Chart 12

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Enterprise Has A Top-Tier Management Team

In our opinion, Enterprise has one of the strongest management teams and track records. It has proactively adjusted to evolving industry trends while remaining focused on preserving balance sheet strength. The partnership has transparently planned and executed its strategy, has considerable expertise and experience, and achieved its financial and operational goals. As a result, we assess its management and governance as strong whereas the other three competitors have satisfactory assessments. This isn't to say we view the other management teams as less qualified or lacking experience. Rather, Enterprise has targeted lower leverage and operated there for many years. Its management team has stood out as leading the peer group in financial policy and transitioning as well as adapting to new or changing markets. As the peer group continues to target and achieve additional governance thresholds, we could consider strengthening our assessments. For example, in early 2020 we revised upward our overall assessment of Kinder's management and governance as it set and achieved leverage targets. It reduced total debt by billions of dollars and funded its operations with free cash flow.

Adequate Liquidity To Meet Near-Term Debt Maturities

As the largest midstream energy company in North America, Enbridge has a more meaningful amount of near-term debt maturities over the next 24 months with over $15 billion coming due as of year-end 2020. The peer group has between approximately $2.75 billion and $5 billion coming due over that period (Chart 13). These large investment-grade companies make up a meaningful portion of the outstanding investment-grade rated midstream energy debt. Though debt capital markets for energy companies temporarily closed at the start of the pandemic, many investment-grade midstream energy companies took advantage of low interest rates to opportunistically refinance upcoming debt maturities. For example, both Kinder and Enterprise issued debt at the lowest coupon rates ever for certain tenors. Should market access become limited or unfavorable, we believe these companies have sufficient liquidity on their outstanding credit lines to roll maturities, if necessary.

Chart 13

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Table 2

Definitions
Term Meaning
Take-or-pay contracts Shippers are obligated to pay fixed amounts rateably over the contract period regardless of volumes shipped.
Cost of service Rates are based on a reasonable return on investment after accounting for the pipeline's cost of providing service.
Competitive toll settlement (CTS) Negotiatied toll (rate) for volumes transported on Enbridge's Canadian portion of the mainline system.

This report does not constitute a rating action.

Primary Credit Analyst:Mike Llanos, New York + 1 (212) 438 4849;
mike.llanos@spglobal.com
Secondary Contact:Michael V Grande, New York + 1 (212) 438 2242;
michael.grande@spglobal.com
Research Assistant:Colette R Durante, New York

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