Down(grade) but Not Out: What Recent Credit Rating Updates Mean for Midstream

04/21/20 | Michael Laitkep

During periods of market volatility, investors often look at credit ratings as one way of evaluating how a company could hold up under stress. Tightening financial conditions can raise concerns about a company’s ability to access capital markets, and a downgrade from investment grade to high yield can result in higher financing costs. In short, companies that hold an investment grade rating are often better positioned to withstand the financial pressures of a downturn, and in recent years, midstream has largely improved its creditworthiness (read more). However, given the significant uncertainty for energy demand and commodity price weakness caused by coronavirus, the ratings agencies have begun to reassess the sector, which has resulted in numerous ratings actions over the last month. S&P recently released a note detailing how midstream credit ratings are being reviewed in light of recent ratings actions. One of the key criteria S&P is analyzing is midstream counterparty risk, which was echoed in recent releases by Moody’s and Fitch as well. Counterparty risk is being closely scrutinized for midstream companies exposed to a single producer. Given these companies’ dependence on a single customer from a volumes and cash flow perspective, a downgrade to the producer would likely result in a similar downgrade for the midstream company. The large drop in commodity prices has also increased risks to midstream companies with greater commodity exposure or with significant exposure to supply-push pipelines that could be impacted by distressed producers. As shown in the table below, companies deriving a substantial majority of their revenue from a single producer customer were more likely to be downgraded or placed on negative outlook.

Among midstream companies focused on gathering and processing (G&P) or with single customer exposure, recent ratings actions are the result of several factors, including revised commodity price and volume assumptions, consideration of counterparty risk, and the outlook for primary customers. Ratings agencies noted in their analysis that ratings for midstream companies with significant exposure to a single producer customer, such as Antero Midstream (AM), CNX Midstream (CNXM), EQM Midstream (EQM), and Western Midstream (WES), will remain closely tied to ratings for their producer customers. For most of these midstream operators, the concern is that a high level of dependence on producer businesses with uncertain outlooks could lead to lower volume growth and a weaker cash flow outlook in addition to company-specific concerns. S&P, for instance, noted it is monitoring progress on EQM’s Mountain Valley Pipeline project, which has been delayed due to construction and regulatory issues. In its update on AM, Moody’s cited operations that were relatively concentrated in Appalachia, commodity exposure, and continued capex requirements among the factors that led to the downgrade.

While the number of recent ratings updates is significant, it belies the lack of action for many of the better positioned names in the space. For example, S&P and Fitch affirmed Plains All American’s (PAA) BBB- rating with a stable outlook. Companies that have retained their investment grade status often possess flexibility given recent debt refinancing and credit facility availability (read more), lower leverage, and higher distribution coverage. For more challenged companies, management could decide to cut dividends when necessary as a way of accelerating balance sheet improvements, and many already have over the last month (read more). As shown in the table below, the Alerian Midstream Energy Index (AMNA), a broad composite index containing North American midstream MLPs and C-Corps, had a substantial investment grade weighting of 86.7% at the end of March, while the Alerian MLP Infrastructure Index (AMZI) was slightly lower at 69.3% (see chart below). Among the AMZI and AMEI indexes, Western Midstream (WES) is the only constituent that was downgraded from investment grade to high yield after all three agencies lowered its rating in conjunction with a downgrade for its primary customer, Occidental (OXY), in March. Overall, the weighting of investment grade companies in midstream and MLP indexes remains robust, with a majority of Alerian midstream index constituents by weighting having an investment grade rating. While some midstream companies may have to take short-term action to preserve their investment grade status, these companies are also more likely to have levers to pull to improve their balance sheet. As mentioned above, S&P and Fitch reaffirmed PAA’s investment grade rating after it cut its distribution by 50% in early April. While more ratings updates are likely in the coming weeks, proactive moves to strengthen balance sheets, reduce spending, and increase financial flexibility can help midstream weather current headwinds.