Fitch Affirms DCP Midstream, LLC and DCP Midstream Partners, LP; Partners' Outlook Revised to Stable
DCP Midstream LLC
--Long-term Issuer Default Rating (IDR) at 'BB+';
--Senior secured rating at 'BB+/RR4';
--Senior unsecured rating at 'BB+/RR4';
--Junior subordinated notes at 'BB-/RR6'.
DCP Midstream Partners, LP
--Long-term IDR at 'BBB-';
--Senior unsecured rating at 'BBB-';
--Short-term IDR and commercial paper rating at 'F3'.
DCP's Rating Outlook is Stable. DPM's Rating Outlook has been revised to Stable from Negative.
The rating affirmations reflect the size and scale of DCP and DPM, their supportive sponsors, and improvements in liquidity, cash flow profile, and operating margin at the DCP enterprise. DCP and DPM have focused on driving down their breakeven costs and increasing their exposure to fixed fee revenue sources. The affirmation reflects the structural subordination of DCP's debt to DPM while recognizing that cost improvements and a move towards more fixed fee revenue sources at DCP are expected to help bolster its cash flow levels. Concerns include volumetric risks, hedge roll off, and uncertainty around growth prospects and ultimate organizational structure.
The Stable Outlook for DPM reflects Fitch's continued expectation for volume weakness in select regions offset in part by DPM's fixed fee and hedged positions for the balance of 2016 and for 2017 and limited expected capital needs. DPM's near term gross margin profile remains fixed fee and hedged keeping near term commodity price exposure low with 90% of gross margin either fee-based or hedged for 2016 (approximately 75% fixed fee/approximately 15% hedged) and roughly 82% of gross margin fee-based or hedged for 2017 (approximately 80% fixed fee/approximately 2% hedged). This provides some near-term comfort around the stability of DPM's earnings and cash flows even in this lower commodity price environment at least through the end of 2017 though the roll-off of hedges will introduce some increased commodity price exposure in 2018 and beyond.
KEY RATING DRIVERS
Scale & Scope of Operations: DCP is the largest independent 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, Mid-Continent, East Texas-, 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. Additionally, the company's large asset base provides a platform for growth opportunities across its footprint. DCP has a particular focus on the DJ and the Permian Basin, areas in need of gathering and processing infrastructure as production in the liquids rich regions of these plays continues to increase. Much of DCP's asset portfolio are 'must-run' type assets as long as oil and gas is flowing from the wells and basin they access, DCP will process the gas.
Supportive Ownership: DCP's owners Spectra Energy (SE; Fitch rates SE's operating subsidiary Spectra Energy Capital LT-IDR: 'BBB'/Rating Watch Positive) and Phillips 66, Inc. (PSX; not rated) have in the past exhibited a willingness to inject capital, forgo dividends, and generally provide capital support most recently with a $3 billion cash and asset equity injection in 2015. The $3 billion equity contribution is illustrative of the value and support that SE and PSX see in and provide to DCP, and by extension DPM. Fitch expects DCP's owners to continue to provide similar support to DCP going forward including continuing to forego dividends while DCP remains under financial pressures stemming from low commodity prices. Should SE and PSX no longer express or possess the willingness and ability to support DCP in times of need Fitch would likely take a negative ratings action. On a purely standalone basis without parental support, DCP's IDR would likely be lower rated.
Modest Leverage at DPM: Fitch expects DPM leverage is expected to range between 4.0x to 4.5x through 2019 with distribution coverage at 1.0x. Fitch would likely take a negative ratings action should DPM fail to maintain leverage below 4.5x on a sustained basis, distribution coverage above 1.0x, and a fixed-fee or hedged gross margin profile of greater than 70%. Cost-of-capital, capital market access, uncertainty around growth and ultimate structure, and the ability and willingness of DPM to fund any capital needs with a focus on keeping leverage at reasonable levels remain additional concerns for DPM.
Fitch expects DCP's credit metrics on both a consolidated and standalone basis to be weak in 2016 but improve in outer years as it benefits from its cost improvements, increased fee based revenue and a rising commodity price deck. Fitch expects standalone leverage at DCP as defined as DCP Debt(inclusive of 50% equity credit)/DCP adj. EBITDA (DCP non-consolidated EBITDA plus distributions from DPM and distributions in excess of equity in earnings) is expected by Fitch to improve to below 4.5x in 2018 and beyond. Fitch's current commodity price base case assumes an improvement in natural gas, oil and NGL prices in 2016, 2017 and long term.
Improved Cash Flow Profile: DCP has taken several active measures to improve its operations and cash flow profile. DCP and DPM have been actively realigning contracts with their counterparties in order to shift to a greater percentage of fee based contracts. Fitch expects DPM to have over 80% of its gross margin fixed fee or hedged for the next few years and DCP has improved its fixed fee or hedged margin to approximately 65% fee or hedged for 2017 which should help stabilize cash flows for both entities. DCP has begun entering into hedges a new practice for the entity which will help DCP level cash flow stability. Additionally, DCP and DPM have been driving a significant amount of operating costs out of the business. As a result, the enterprises breakeven costs have declined significantly to well below $0.35 per gallon for NGLs, representing a significant decline from prior pre-2015 levels of over $0.60 per gallon.
Volumetric Risk: Fitch is concerned with volumetric risks across DCP's and DPM's asset base. While volumes in the DJ and Permian Basins are expected to continue hold up well, elsewhere Fitch expects volume declines, particularly in the Eagle Ford region. Near-term volume declines could weigh on profitability across DCP and DPM, but Fitch expects a rising price deck should help moderate volumetric risks in 2018 and beyond as commodity prices improve and production begins to return.
Hedges Rolling Off: DPM's hedges continue to roll off, negatively impacting profitability going forward. DPM has historically balanced its open commodity price exposure by hedging its NGL, crude oil and natural gas exposure on a 12 to 18 month basis. As prices have fallen and remained low the ability for DPM to enter into favourable hedges also declined. To offset hedge roll off DPM has been steadily increasing its fee based margin profile in part by incorporating NGL pipeline assets, which are largely fee based but subject to some volume risks. Fitch expects DPM's fee based profile to remain above 80% in 2017.
Fitch's key assumptions within our rating case for the issuer include:
--Base case commodity prices are consistent with Fitch's price deck. Fitch's price deck assumes modestly rising commodity prices, with WTI of $42/bbl for 2016, $45/bbl for 2017 and $55/bbl for 2018 and a long-term price of $65/bbl. Henry Hub natural gas of $2.25/mcf for 2016, $2.50/mcf for 2017, $2.75/mcf for 2018, and $3.25/mcf long term.
--Volume declines in 2016 and 2017 with very modest volume growth in 2018 and 2019 as commodity prices rise and production starts to recover.
--Maintenance capital at DPM of roughly $50mm annually.
--DPM's 2017 maturity assumed to be refinance at DPM at a 6.5% coupon.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--Leverage expected above 4.5x on a sustained basis and/or distribution coverage consistently below 1.0x would likely result in at least a one notch downgrade.
--A significant decline in fixed fee or hedged commodity exposed gross margin to less than 70% fixed fee or hedged without an appropriate, significant adjustment in capital structure, specifically a reduction in leverage, would likely lead to at least a one notch downgrade.
--Acceleration of dropdowns that results in significantly increased leverage or commodity price exposure at DPM could lead to a negative ratings action at DPM.
--A significant change in the ownership support structure from SE and PSX to DCP Midstream, and from all three to DPM, particularly with regard to commodity price exposure, distribution policies at DCP and DPM, and capital structure.
--Significant volume declines leading to margin and earnings pressure.
--If DPM's ratings were to move lower Fitch would consider a negative ratings action at DCP given DCP's near-term reliance on DPM distributions to support operations and service debt.
--A significant change in the ownership support structure from SE and PSX to DCP Midstream, particularly with regard to distribution policies at DCP and DPM, increased commodity price exposure, and capital structure.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
--For DPM the exhibited ability to increase the percentage of fixed fee or hedged gross margin for 2017 and beyond to above 70% while maintaining leverage below 4.0x and distribution coverage above 1.0x on a sustained basis could lead to a positive ratings action.
--For DCP the improvement of standalone DCP LLC leverage to between 4.0x to 4.5x on a sustained basis could lead to a positive rating action.
Liquidity adequate: DCP and DPM have adequate liquidity. DCP LLC recently renegotiated its secured revolving credit facility downsizing it to $700 million, pushing its maturity date out to May 2019 and increasing the security package securing the revolver. The revolver is secured by the equity interest in DPM and DCP's other operating subsidiaries. The revolver has certain financial covenants which largely go into effect in the 1Q 2017. Along with other restrictions, the terms of this facility only allows for payment of distributions, except for certain tax distributions related to the sale of assets, to Phillips 66 and Spectra, if DCP has no outstanding borrowings and meets certain leverage and liquidity thresholds. As of Sept. 8, 2016 DCP had full availability under the revolver.
DPM has access to a $1.25 billion unsecured revolving credit facility which matures in May 2019. As of July 29, 2016, DPM had $125 million of outstanding borrowings on the revolving credit facility and had approximately $1,125 million of unused borrowing capacity. DPM's revolver requires maintain a leverage ratio (as defined in the agreement) of not more than 5.0x, as of June 30, 2016 this ratio was 3.4x. Fitch expects both DCP and DPM to remain in compliance with their respective financial covenants over the 2016-2019 forecast period.
DCP and DPM's near term maturities are manageable. At DCP the extension of the revolver to 2019 means there are no near-term maturities at DCP until 2019. At DPM there is a $500 million maturity in December 2017. Fitch expects based on current market conditions that DPM will be able to refinance that maturity or have enough availability on its revolving credit facility to repay the note at maturity.