A positive equity market response to cuts in dividends has the potential
to make similar distribution cuts palatable to other U.S. midstream
energy issuers in need of capital market funding options, according to
Fitch Ratings. However, we do not believe that significant dividend and
distribution cuts will be the norm for investment-grade midstream energy
companies, as was the case with Kinder Morgan's (KMI) 75% cut.
Equity prices for midstream issuers are down because of lower equity
prices, lower growth expectations, and a rotation out of energy
investments. With the declines in equity, the issuers' abilities to
access capital markets to fund growth spending with equity has become
economically challenged, sending many issuers scrambling to find
alternative sources of equity funding. KMI's announcement could
encourage other midstream issuers to follow suit in cutting dividends or
distributions, although at this point Fitch does not believe it is
necessary for issuer to pursue cuts.
Fitch believes that the KMI dividend cut was generally positive for its
credit profile. The cut alleviates the need for KMI to access equity
markets and lessens the need for it to access debt markets to help fund
what remains a large growth spending backlog. However, the issues facing
KMI were relatively unique to KMI given its high leverage, and large
backlogged growth spending budget. While there are other issuers facing
similar situations their leverage metrics are generally a bit better and
other equity funding alternatives are available.
Cuts in dividend or distribution growth rates may be a logical first
step for issuers who are not under the same leverage pressures that KMI
was facing and may not need as steep cuts. Other funding possibilities
include asset sales, joint ventures, sponsor support, preferred equity,
convertibles, or hybrid-subordinated debt. Fitch expects an "all of the
above" pursuit of these options as issuers look to fund capital needs
with whatever makes the most economic sense.
Ultimately Fitch believes issuers, particularly master limited
partnership (MLP) issuers, will pursue a funding strategy that they
believe offers the lowest available cost of capital. Issuers, especially
the larger investment-grade rated midstream energy companies with growth
capital funding needs, will move to defend investment ratings at the
expense of dividends and distributions if necessary. For high yield
names funding problems are currently much more pronounced, with equity
markets essentially closed and bond spreads dramatically higher,
although liquidity is generally acceptable with availability under
revolvers adequate and existing debt maturities well spread out.
Distribution cuts here could provide some funding access relief. Fitch
would tend to view cuts in dividends and distributions resulting in
higher distribution coverage and cash retention to fund capital needs as
neutral to positive for credits.
Overall, Fitch has a negative sector and rating outlook for the U.S.
Midstream Services sector for 2016. Continued low commodity prices,
increased counterparty risk, potential volume declines, constricted
capital market access, and rising leverage could lead to negative
ratings actions or outlook changes within Fitch's midstream services
coverage. Fitch expects that 2016 revenue and cash flow for oil and gas
gathers and processors, in particular, will continue to exhibit weakness
resulting from low prices and production volume declines. Fitch does
believe that natural gas pipelines and crude oil and refined products
pipelines should all be relatively stable for 2016 given the contractual
support underpinning most operations.
For further insight on our expectations for the U.S. midstream sector,
please see the following outlooks available on our website at www.fitchratings.com:
"2016 Outlook: U.S. Midstream Services"
"2016 Outlook: U.S. Crude Oil and Refined Products Pipelines"
"2016 Outlook: U.S. Natural Gas Pipelines"
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit
market commentary page. The original article, which may include
hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com.
All opinions expressed are those of Fitch Ratings.
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