DBRS Confirms Pembina Pipeline Corporation at BBB and Pfd-3, Trend Stable

DBRS has today confirmed the Issuer Rating and Senior Unsecured Notes of Pembina Pipeline Corporation (Pembina or the Company) at BBB, and the Preferred Shares at Pfd-3. The trends remain Stable. The confirmation largely reflects DBRS’s view that the Company’s exposure to fractionation spreads and seasonal pricing differentials has lowered considerably while its financial profile has improved over the past 24 months (since the April 2, 2012, closing of the Provident acquisition (the Acquisition)). The confirmation also reflects DBRS’s expectation that: (1) further improvement of the business risk profile will be achieved once the Company substantially completes all of its current expansion projects; and (2) Pembina will continue to finance its expansion with appropriate debt and equity to maintain its debt-to-capital structure in the range of below 40% and cash flow-to-debt ratio at least 25%.

Pembina’s business risk profile has improved considerably since the Acquisition due to the following factors: (1) Pembina’s exposure to the more volatile product margin and fractionation spread businesses was reduced, as Provident’s legacy product margin contracts were replaced by fee-for-service (FFS) contracts. (2) All new capital projects that have come into service since the Acquisition were either take-or-pay contracts or FFS contracts. (3) The Conventional Pipeline segment, the largest cash flow contributor to Pembina, has benefited from increased natural gas liquids (NGL) and crude oil drilling activities in the Deep Basin, Cardium and Montney regions. Pembina has been replacing market-based contracts in this segment with take-or-pay contracts, further reducing volume risk for this segment. At the time of the Acquisition, earnings contribution from take-or-pay, cost-of-service, FFS and product margin businesses accounted for approximately 51% of total consolidated EBIT. This portion increased to approximately 70% by the end of 2012 and to approximately 86% by the end of 2013 (DBRS estimates). This stable cash flow should further improve over the medium term as most of the Company’s current capital projects are supported by at least 75% take-or-pay contracts.

Pembina’s financial profile strengthened significantly in 2013 reflecting strong incremental cash flow from new investments and a conservative financing strategy to date. Total debt-to-capital declined to 31% (2012: 37%) and cash flow-to-debt increased to 33% (2012: 19%). In 2013, the capital structure was supported by a modest debt reduction, equity and preferred shares issuances, as well as a dividend reinvestment plan, which accounted for approximately 57% of 2013 dividends, and reduction in payout ratio.

Pembina is currently pursuing a number of large capital projects, mainly on its conventional pipelines, and natural gas and NGL processing plants. Most projects have received take-or-pay commitments from the producers for a significant portion of designed capacity (see the Project section). Capital expenditures in 2014 is estimated to be $1.7 billion – substantially higher than the 2013 level. As a result, large free cash flow deficits are expected to be incurred over the next two years. DBRS acknowledges that over the medium term, Pembina faces a few challenges such as: (1) Significant project execution risk is expected with respect to cost overruns and project delays. However, this risk is mitigated by the fact that Pembina has a proven track record to complete its projects on time and within budget (the Mitsue and Nipisi projects in 2011, the Phase I NGL Expansion in 2013, the Saturn I project in Q4 2013, and the Simonette project in 2014). (2) Continuing to adhere to its conservative financing strategy to finance free cash flow deficits so as to maintain credit metrics at or close to current levels. (3) Continuing to manage its exposure to commodity price risk and fractionation spread risk, and maintain assets in, and cash flow from, this business to 10% of overall assets and cash flow.

DBRS recognizes that during this period of large capital projects, Pembina’s credit metrics are expected to deteriorate modestly and should improve once the major projects are completed. However, should the financial profile deteriorate significantly from the current level, a negative rating action could occur. On the other hand, a positive rating action could be taken should Pembina successfully complete its major projects on time and within budget while maintaining the debt leverage below the 40% level (31% at December 31, 2013) and the cash flow-to-debt at least 25% (33% in 2013) on a sustained basis.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodology is Rating Pipeline and Diversified Energy Companies, which can be found on our website under Methodologies.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.