Fitch Downgrades DCP Midstream LLC to 'BBB-'; Affirms DCP Midstream Partners; Outlook Negative
The ratings action reflects the negative impact that the severe downturn in commodity prices is having and is expected to have on DCP enterprise's profitability and credit metrics. DCP, in particular, retains a significant amount of commodity exposure and the recent declines in natural gas liquids (NGLs), crude oil, and natural gas prices is expected to stress profitability at the assets remaining in DCP and push the company's credit metrics well above and beyond levels previously projected by Fitch and historically targeted by management. DPM is expected to better withstand price weakness in the near term. DPM's fixed fee profile is much stronger with roughly 90% of 2015 gross margin either fixed-fee or hedged, though a significant portion of the hedges are with DCP.
Historically, DCP has targeted between 2.5x to 3.5x debt/EBITDA (on a standalone basis) at the LLC level to offset the high commodity price exposure DCP maintained at the DCP level. Prior to the most recent downturn in commodity prices Fitch was forecasting 2015 DCP standalone (inclusive of distributions from DPM) debt/EBITDA of roughly 3.0x to 3.5x in 2015 and 2016 based on an assumed composite NGL barrel of roughly \$0.80/gallon. Fitch's expectations have deteriorated along with commodity prices and now expects leverage to be roughly 7.5x - 8.5x for 2015 and 2016 on a standalone basis based on current forward commodity prices.
Fitch believes DCP will look to pursue several options in order to protect its investment grade rating. These options include cutting distributions to its owners, Spectra Energy Corp (SE; Fitch rates operating subsidiary Spectra Energy Capital BBB/Stable Outlook) and Phillips 66 (PSX), selling assets, dropping down assets into its master limited partnership, DPM, cutting costs and decreasing discretionary capital spending. An inability to address DCP's significantly increased leverage in the next 6 to 8 months could lead to a downgrade. On Friday January 30th, 2015 DCP announced a large scale corporate restructuring which will see a large reduction in workforce. This step should generate significant cost savings but is not enough to fully offset commodity price declines.
Fitch believes that DCP continues to own and operate 'must run' type assets with significant scale and decent geographic diversity. DCP is the largest stand-alone natural gas processor in the United States, and it has a robust presence in all of the key production regions within the country. DCP owns or operates gathering & processing systems in Permian, Eagle Ford, Rockies, Mid-Continent, East Texas-North Louisiana, South Texas, Central Texas, as well as, the Piceance and Barnett Shale basins. The size and breadth of DCP's operations allow it to offer its customers end-to-end gathering, processing, storage and transportation solutions giving DCP a competitive advantage within the regions where they have significant scale.
The Negative Outlook for DPM reflects parent subsidiary ratings linkage. Historically, Fitch has limited DPM to a one notch separation between DCP and DPM, given the strong operational and financial linkage DPM has with DCP and indirectly with DCP's owners, SE and PSX. DCP's ownership of DPM's GP interest gives DCP significant control over DPM's operations, including major strategic decisions such as dropdown opportunities, investment plans, distributions, and management of operations, as well as centralized treasury functions. DCP has also historically provided significant support for DPM including a demonstrated willingness to take back units as equity contributions for dropdown transactions, as well as, providing hedges and fixed demand charges and throughput fees for dropped down processing plants. Meanwhile, DPM provides DCP a low cost source of financing and access to equity markets. DPM remains significantly hedged keeping near term commodity price exposure low with 90% of gross margin either fee-based or hedged for 2015 and over 70% of gross margin fee-based or hedged for 2016 providing some comfort around the stability of DPM's earnings and cash flows even in this lower commodity price environment, though Fitch recognizes much of these hedges are with DCP.
Fitch expects DCP, SE, and PSX to continue to support DPM's credit quality including maintaining a capital structure, fixed-fee profile and business risk profile in line with other investment grade MLPs and maintaining a solid distribution coverage ratio. Fitch would likely move DPM below investment grade if there were a significant change in support from its sponsors resulting in a move away from its current focus on maintaining its fixed-fee or hedged revenue profile or there were expectations that leverage was going to remain above 4.5x on a sustained basis. Significant growth in commodity exposed earnings without an appropriate, significant adjustment in capital structure, specifically a reduction in leverage would result in a downgrade. Fitch typically targets at minimum a 70% fixed fee revenue profile (in addition to other factors particularly leverage below 4.5x) as being reflective of investment grade for credit quality for master limited partnerships.
KEY RATINGS DRIVERS
DCP
Scale & Scope of Operations: DCP is the largest stand-alone natural gas processor in the United States, and it has a robust presence in all of the key production regions within the country. Additionally, the company's large asset base provides a platform for growth opportunities across its footprint. DCP has a particular focus on the Eagle Ford shale, the Rockies and the Permian Basin, all areas in need of gathering and processing infrastructure as production in the liquids rich regions of these plays is increasing.
Commodity Price & Volumetric Exposure: DCP does not hedge its commodity risk directly. Instead, it tries to balance its contract mix to help reduce exposure to commodity price volatility while still providing upside should commodity prices strengthen. Additionally, DCP, like every processor, has volume exposure; however, production in DCP's liquids rich regions continues to be a focus for producers. DCP has seen volume growth even as prices have dramatically declined.
Deteriorating Credit Metrics: DCP's management has typically targeted between 2.5x - 3.5x debt-to-EBITDA throughout the commodity price cycle and greater than 5.0x EBITDA interest coverage (excluding EBITDA of its master limited partnership [MLP] subsidiary DPM and non-recourse debt). Prior to the most recent capital spending cycle DCP consistently met these targets even in low commodity price environments. The recent fall in commodity prices will push leverage metrics well outside of these bounds. Fitch has listed sustained standalone leverage above 4.5x as a downgrade trigger and believes that leverage will remain well above these bounds over the next two years, provided there are no steps taken by management or sponsors to significantly reduce leverage and get DCP on a path towards the 4.5x. Liquidity is adequate currently; however, DCP is expected to need covenant relief in the next several quarters. Fitch expects DCP would be able to receive relief; however, if it did not, a negative rating action would be likely.
Supportive Ownership: DCP's owners have in the past exhibited a willingness to forgo dividends, provide capital support in the form of co-investment on growth projects and a willingness to allow DCP to operate within its operating cash generation as capital market access tightened and commodity prices fell during the 2008/2009 down cycle. Fitch expects DCP's owners to continue to provide similar support to DCP. Fitch would likely take further negative ratings actions should SE or PSX be reticent or show an unwillingness to provide support in the form of distribution cuts, or capital injections if and as needed over the next 6 to 12 months.
DPM
Sponsor Relationship: DCP's ownership of DPM's GP interest gives DCP significant control over DPM's operations, including major strategic decisions such as dropdown opportunities, investment plans, distributions, and management of operations, as well as centralized treasury functions. DCP has also historically provided significant support for DPM including a demonstrated willingness to take back units as equity contributions for dropdown transactions, as well as, providing fixed demand charges and throughput fees for dropped down processing plants. Meanwhile, DPM provides DCP a low cost source of financing and access to equity markets. Fitch would likely not rate DPM higher than DCP based on the financial, strategic and operational relationship between the entities, but does not currently believe DPM should move to below investment grade, given the cash flow stability, structural superiority and reasonable credit metrics at the partnership. Fitch expects DCP, SE, and PSX to continue to support DPM's credit quality including maintaining a capital structure and business risk profile in line with other investment grade MLPs and maintaining a solid distribution coverage ratio.
Cash Flow Stability: DPM possesses relatively predictable cash flows that are supported by the partnership's portfolio of fee-based assets and an active hedging program that helps moderate commodity price exposure. Near-term commodity price exposure is low with roughly 90% of gross margin either fee-based or hedged for 2015 and roughly 70% for 2016 (with 60% beyond 2016). DPM actively manages the majority of its commodity exposure through a hedging program, with shorter tenor direct hedges on NGLs and longer dated swap positions on natural gas and crude oil as a proxy for NGLs. Natural Gas and NGL hedges have typically been provided by DCP.
Strategic Location of Assets: DPM benefits from the strategic location of its midstream assets, which touch several core U.S. natural gas producing basins and are often integrated with assets owned by DCP, and the strategic location of DPM's wholesale propane terminals which serve high-volume retailers in Northeast markets. As such, DPM achieves steady demand from its core customers as well as good growth opportunities for organic investments.
Volume Sensitivity: While taking significant steps to mitigate the volatility of prices, DPM has exposure to throughput volumes on its assets. DPM has some take-or-pay agreements that eliminate volumetric risk. Lower volumes can be driven by many factors including: lower throughput on the partnership's gathering and processing assets due to reduced production from upstream producers, lower throughput due to lower upstream production or due to bypassing NGL processing facilities when natural gas prices are very high and lower propane volumes delivered through its terminals due to warm weather, conservation and fuel switching. Should volumes significantly decline Fitch would likely take negative ratings actions.
RATINGS SENSITIVITIES
DCP
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--Inability or unwillingness to address current challenging operating environment and high leverage, through some combination of reductions in capital spending, distributions to owners, and/or operating costs or equity injection, could lead to a further downgrade. Fitch would expect a plan to get DCP on a path towards sustainable leverage at 4.5x or below in order to maintain current rating.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Improvement of stand-alone DCP LLC leverage of between 4.0x to 4.5 on a sustained basis would likely lead to a revision of the Negative Outlook.
Significant reduction in commodity price exposure to 30% of gross margin or below at DCP could lead to a positive rating action.
DPM
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--DPM leverage above 4.5x on a sustained basis would likely result in at least a one notch downgrade;
--A significant change in the support structure from DCP Midstream, particularly with regard to helping mitigate DPM commodity price exposure, without increasing DPM's liquidity or an appropriate change to the hedging strategy to mitigate price exposure at a reasonable cost;
--Significant growth in commodity exposed earnings not hedged or fixed fee to more than 30% of gross margin exposed without an appropriate, significant adjustment in capital structure, specifically a reduction in leverage to below 3.5x would likely lead to at least a one notch downgrade;
--Acceleration of dropdowns funded by more than 50% debt or which results in significantly increased commodity price exposure at DPM. Aggressive funding of growth capital spending with debt at levels above 50%/50% debt/equity could lead to a negative ratings action;
--A downgrade at DCP could lead to a downgrade at DPM if it results in increased commodity price risk at DPM.
Positive
--A revision of the Negative Outlook for DCP could lead to a positive rating action at DPM;
--Increase in third party hedging and price support at DPM could lead to a positive rating action.
Fitch downgrades DCP's ratings as follows:
--IDR to 'BBB-' from 'BBB';
--Senior unsecured to 'BBB-' from 'BBB';
--Short-term IDR to 'F3' from 'F2'
--Jr. Subordinated to 'BB' from 'BB+'.
Fitch affirms DPM as follows:
--IDR at 'BBB-';
--Senior unsecured rating at 'BBB-';
--Short-term IDR and commercial paper rating at 'F3'.
The Ratings Outlook for both DCP and DPM has been revised to Negative from Stable.
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