NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has placed Southern Natural Gas Company (SNG) on Rating Watch Positive following the announcement that Southern Company (SO; 'A-'/Stable Outlook) will purchase a 50% stake in the natural gas pipeline system from Kinder Morgan Inc. (KMI; 'BBB-'/Stable Outlook). Fitch currently rates SNG as follows:
--Long-Term Issuer Default Rating (IDR) 'BBB-';
--Senior unsecured rating 'BBB-'.
In association with the transaction, SNG will be released from the cross guarantee that it currently provides to KMI and its other rated subsidiaries. As a result of SNG's release from the cross guarantees, Fitch expects to rate SNG on its standalone credit profile at or near the close of the transaction. Given the low risk nature and stable cash flow of SNG's pipeline system, Fitch believes that SNG's credit profile is more consistent with a 'BBB+' Long-Term IDR. The transaction is subject to Hart-Scott-Rodino review and is expected to close sometime before year-end 2016.
SNG's ratings are reflective of the low risk nature of the FERC-regulated natural gas pipeline system coupled with solid credit and financial operating metrics and the expected release of the cross guarantee to KMI's debt. The acquisition of a 50% interest in the pipeline by higher rated SO, which also holds roughly 50% of the capacity on the pipeline, should benefit SNG from a strategic basis, aligning the pipeline with its largest customer and providing some expansion opportunities for the pipeline system. Fitch expects leverage at SNG to be between 3.0x and 3.3x, with interest coverage of roughly 5.0x for 2016-2018.
KEY RATING DRIVERS
Strong Strategic Ownership: KMI and SO represent strong strategic owners of the SNG pipeline system. Following its recently completed merger with AGL Resources, Inc. (AGL; IDR 'BBB+'/Stable Outlook), SO has become one of the largest natural gas consumers and distributors in the country. The SNG system fits strategically with SO's gas distribution service territories and the locations of its gas-fired generating plants. KMI is currently the largest midstream infrastructure company in the U.S., possessing a strong, diverse asset portfolio which spans multiple business lines, including the largest interstate natural gas pipeline system in the country allowing access and delivery capability to all of the major gas production and demand regions in the country. The sale of SNG allows KMI to monetize an asset and pay down debt while continuing to maintain an operating interest in an asset with strong cash flows and appealing growth prospects. Both owners should provide operational and growth benefits to SNG going forward.
Stable Earnings and Cash Flows: SNG's revenue and cash flow profile is supported by long-term capacity reservation contracts with a strong majority of investment grade counterparties which provide most of the pipeline system's revenue independent of volumes shipped through the system or commodity prices. SNG's contracts are largely demand pull contracts with utility counterparties, with the new owner, SO, being the largest holder of capacity on the system.
Geographic Advantages: SNG serves the south eastern U.S. where Fitch expects gas demand to grow moderately in the near-to-intermediate term. SNG is the principal natural gas transporter to southeastern markets in Alabama, Georgia and South Carolina. These states are part of the fastest growing natural gas demand regions in the U.S. With the addition of SO as an owner, SNG should benefit from positive demand trends in SO's service territories.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for SNG include:
--The $500 million April 2017 maturity is assumed to be refinanced at SNG.
--All cash available for distribution assumed to be paid as dividends to owners.
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
--The closing of the proposed acquisition of SNG by SO and the release of SNG from its KMI cross guarantee will likely lead to a positive rating action. Given the low risk, stable cash flow profile and leverage in the range of 3.0x to 3.5x, Fitch believes that SNG's stand-alone credit profile is more consistent with a 'BBB+' Long-Term IDR. If Fitch expected leverage to range between 3.5x-4.5x on a sustained basis, it would likely lead to a more muted positive rating action at SNG.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--A significant change in cash flow stability profile. A move away from current significant majority of capacity being contracted with investment grade counterparties.
--Leverage above 4.5x on a sustained basis would likely lead to either an affirmation at current rating levels or a negative ratings action.
LIQUIDITY
Liquidity at SNG is adequate with the pipeline generating roughly $300 million in free cash flow before dividends and working capital needs are low. Maturities are manageable with $500 million in notes coming due April 1, 2017. Fitch expects these notes to be refinanced at the SNG level.
FULL LIST OF RATING ACTIONS
Fitch has placed the following ratings on Rating Watch Positive:
Southern Natural Gas Company
--Long-Term IDR 'BBB-';
--Senior unsecured rating 'BBB-'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
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Fitch Ratings
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Fitch Ratings, Inc.
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Source: Fitch Ratings
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