Energy

Could Kinder Morgan's Investment Grade Credit Rating Be at Risk?

Jon C. Ogg

Published: December 1, 2015 12:05 pm

Last Updated: January 13, 2020 4:36 pm

Kinder Morgan Inc. (NYSE: KMI) is one of the most widely followed energy-related companies in America. The former master limited partnership (MLP) has run into an energy sector crunch since converting back to a corporation, and now there is often less enthusiasm and more caution on behalf of many investors and analysts. So how will investors react when they see that the credit ratings agency Moody’s changed Kinder Morgan’s outlook to Negative from Stable?

Many credit ratings reviews are for show. What stands out here is that Moody’s said that approximately $44 billion of rated debt is affected by the outlook change. Before getting too deeply into what Moody’s has said in its credit action, note that the other two key credit ratings agencies (Fitch and S&P) have not taken this same stance (see below) in their views and reactions.

Kinder Morgan is extremely active in daily volume, it is still owned heavily by many MLP investors, and it is heavily owned by MLP closed-end funds that track the sector. This company is the largest midstream energy company in the North America via a vast network of product pipelines, natural gas pipelines, terminals and production and transportation assets.

Moody’s Investors Service did affirm Kinder Morgan’s Baa3 senior unsecured and Prime-3 commercial paper ratings. What matters here is that Baa3 is the last line of investment grade. If Kinder Morgan gets a credit rating downgrade, that means that at least some of its credit ratings may no longer be investment grade.

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One of the first things mentioned here in Moody’s credit rating review was that the company announced on November 30 an agreement to increase its ownership in Natural Gas Pipeline Company of America (NGPL) to 50% from 20% for approximately $136 million. Brookfield Infrastructure Partners L.P. (NYSE: BIP) will own the remaining 50%. Moody’s showed that the proportionate consolidation of NGPL’s debt will add about $1.5 billion to Kinder Morgan’s consolidated debt, while NGPL’s trailing 12-month gross EBITDA was $273 million. The transaction valued NGPL at a total enterprise value of $3.4 billion, inclusive of existing debt.

So, what about those other calls? Fitch and S&P ratings data are as follows:

• Fitch Ratings expects the announced acquisition of a 30% interest of Natural Gas Pipeline Company of America LLC (NGPL) to be neutral to Kinder Morgan Inc. (KMI; ‘BBB-‘/Stable Outlook).
• Standard & Poor’s Ratings Services said today that the rating and outlook on Kinder Morgan are unaffected after the company announced a definitive agreement to increase its ownership interest in NGPL to 50% from 20%. … KMI’s investment in NGPL does not change our view of the company’s expected credit measures…

Moody’s said:

The negative outlook reflects Kinder Morgan’s increased business risk profile and additional pressure on its already high leverage that will result from its agreement to increase ownership in NGPL, a distressed company. NGPL is facing potential default on its pending interest payments, suggesting that KMI will need to provide cash injections, which will likely be debt funded initially.

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Additional assumptions, for potential improvements or downgrades, were listed by Moody’s as follows:

The negative outlook could be restored to stable if KMI appears likely to have consistent Moody’s adjusted debt to EBITDA of 5.8x or below.

The ratings could be downgraded if it appears that Moody’s adjusted debt to EBITDA will not be consistently 5.8x or below, distribution coverage appears likely to fall below 1x, business risk increases or if the company undertakes an acquisition that increases leverage or does other debt financed activities where the company is highly reliant on equity markets to bring down leverage. The rating could be upgraded if Moody’s adjusted debt to EBITDA appears to be sustainable below 5.0x.

What may matter to some investors is that Moody’s is calling NGPL’s capital structure untenable in its ratings rationale. Its debt/EBITDA was said to be currently above 10, and it was noted that there is insufficient liquidity to fully fund pending interest payments and term loan amortization totaling $115 million. The group said:

Moody’s expects that KMI is likely to initially debt fund its share of the needed support, and will need to provide additional support as part of any restructuring of NGPL’s capital structure and its approximate $3 billion of debt. Proportionate consolidation of NGPL along with Moody’s standard adjustments will increase KMI’s leverage to around 5.9x on a December 31, 2015 pro forma basis.

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Kinder Morgan shares were last seen down 3.2% at $22.82 on Tuesday. Its 52-week trading range is $22.57 to $44.71, and its consensus analyst price target is still close to $37.00.

Additional quotes from the Moody’s rating view are shown below:

KMI’s Baa3 rating reflects its significant scale, high quality assets, and fee-based cash flows, tempered by its high leverage and payout of approximately 90% of internally generated cash flow to shareholders. Moody’s forecasted debt to EBITDA for KMI of around 5.9x (6x on a proportionate consolidation basis) in mid-2016 is high for an investment grade company. (Moody’s calculation of adjusted debt to EBITDA increases Kinder Morgan’s measurement of net debt to EBITDA by about 0.2x. Adding the proportionate consolidation of NGPL and Moody’s other adjustments increases KMI’s measurement by about 0.3x). KMI’s year-end leverage focus means leverage (including Moody’s standard adjustments) may be above 5.8x for much of the year, and KMI crucially relies on ongoing equity and debt capital markets access to meet that target. Currently weak capital markets have increased the cost of access. KMI benefits from relatively stable cash flow generated by a combination of long term contracts and regulated returns from energy infrastructure assets. We estimate that about 10% of the company’s operating cash flow is subject to short-term market volatility, primarily related to oil production tied to the CO2 business segment, which we expect to remain weak through 2016 due to low commodity prices.

We expect leverage to remain high throughout 2016 as the company plans to distribute most of its roughly $5 billion of operating cash flow to shareholders. KMI is reliant on both equity and debt markets to fund growth capital expenditures, which will likely exceed $4 billion next year, which in turn supports the company’s distributable cash flow growth expectations of 6% to10%. Master Limited Partnerships (MLPs) and MLP-like companies such as KMI require high growth to satisfy their shareholder bases and maintain strong stock valuations. As shareholder value weakens, due to lower anticipated growth and general contagion from weak oil and natural gas markets, the cost of equity (and debt) increases, making it more difficult for affected companies to raise the equity needed to keep their leverage within acceptable levels for their rating.

As part of the November 2014 re-organization of KMI, a cross-guarantee was executed by most of its domestic, wholly-owned subsidiaries, leading to the Baa3 rating for all of the included entities. Four rated entities are not part of the cross-guarantee group. Three of these entities have issued preferred stock that is rated Ba1: El Paso Energy Capital Trust I, KN Capital Trust I, and KN Capital Trust III. The sole asset of each is subordinated debt of KMI, which was funded by the rated preferred stock, which is the principal liability of each entity. The preferred stock issued by these entities is rated one notch lower than KMI at Ba1, reflecting the credit quality of the subordinated payment obligation of KMI that supports the preferreds. The fourth non-cross guaranteed entity is Kinder Morgan GP Inc., which issued preferred stock that is rated Ba2. This entity has ownership interests that generate about $100 million of annual distributable cash flow and the preferreds have a preferential right to dividends over KMI’s common shareholder. The preferreds are rated two notches below KMI’s senior unsecured rating at Ba2.

KMI’s liquidity is adequate. Through the third quarter of 2016 Moody’s expects the company will have nearly $11 billion of cash from operations and liquidity resources to fund about the same amount of dividends, capital expenditures and debt maturities. The company will have about $5 billion of cash from operations, together with pro-forma cash of $1.7 billion and an essentially unused credit facility of $4 billion (expires 2019). We expect dividends in the mid-$4 billion range, capital expenditures around $4.5 billion, and debt maturities in the fourth quarter of 2015 and first quarter of 2016 totaling $2.4 billion. We also expect KMI to be in compliance with its sole financial covenant (consolidated total debt to consolidated EBITDA not greater than 6.5x).

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