Fitch Ratings expects to rate EQT Midstream Partners, LP (EQM)’s proposed senior unsecured notes ‘BBB-‘. Proceeds from the note offering will be used to repay borrowings on the senior unsecured revolver and for general partnership purposes.
Key ratings drivers:
The ‘BBB-‘ rating is supported by EQM’s fixed fee long-term contracts with a 15-year weighted average contract life as of year-end 2013, low leverage, plans to operate with strong distribution coverage, and strategy to grow via dropdowns from its sponsor, EQT Corporation (EQT; rated ‘BBB-‘/Outlook Stable by Fitch) and to capitalize on organic growth opportunities.
Concerns include EQM’s significant customer concentration with EQT. In the first quarter of 2014, EQT accounted for 51% of revenues. While this is well below customer concentration in 2013, when EQT accounted for 77% of revenues prior to the sale of Equitable Gas Distribution, it remains relatively high. Since the closing of the Jupiter Gathering System (Jupiter) in May 2014, Fitch expects revenues from EQT to significantly increase for 2014 from the first quarter of the year. Other concerns include EQM’s relatively small size and concentration in the Marcellus.
To grow EBITDA and distributable cash flows (DCF) particularly for a public MLP, Fitch expects to see significant spending for growth via dropdowns and organic growth at EQM. The manner in which the partnership funds growth going forward will be a significant driver of future credit quality. EQM’s current adjusted leverage is 2x since it has largely financed growth with equity issuance, therefore, Fitch views the partnership as having the ability to fund growth with additional debt. Since the IPO two years ago, management has grown EQM at a measured pace and conservatively. With the issuance of new notes, Fitch forecasts year-end 2014 adjusted leverage to be under 3x on a pro forma basis for the Jupiter acquisition.
EQM’s sponsor, EQT has an inventory of midstream assets available for future dropdowns. EQM expects to continue to acquire assets from EQT which has a significant and growing inventory of midstream assets. EQT’s midstream assets are strategically located near its own production. Consequently, once assets are moved from EQT to EQM, EQT’s natural gas production fills the majority of midstream assets whether it is transmission, storage or gathering. In addition to dropdowns, EQM has its own growth projects which are bolt-on projects to the existing portfolio of midstream assets.
Fitch views EQT as a driver of EQM’s future growth. In addition to EQT having an inventory of midstream assets for potential dropdowns, Fitch also believes that EQT’s own production growth will provide opportunities for EQM. Between 2009 and 2013, EQT’s sales volumes have increased 39% on a compound annual growth rate. This is substantially above many of its peers and the growth rate is attributed to EQT’s position in the Marcellus/Upper Devonian which attributed to 78% of sales volumes in the first quarter of 2014. The Marcellus/Upper Devonian volumes increased 50% in the recent quarter versus the year ago period. In 2009, EQT’s total production was 284 mmcfe/day. During the first quarter of 2014, it rose to approximately 1,179 mmcfe/day. Furthermore, EQT’s reserve life is 22.7 years when evaluating reserves to production; the more conservative look at reserve life is proved developed/production which is 10.9 years.
Liquidity at EQM appears healthy. As of June 30, 2014, EQM had $26 million of cash on the balance sheet. In addition, it had $420 million available on its $750 million senior unsecured revolver which extends until 2019.
EQM’s bank agreement restricts leverage (as defined by the bank agreement) from exceeding 5.0x at the end of any quarter. With permitted acquisitions which are defined as $25 million or greater in any 12 month period, leverage cannot exceed 5.5x for the next three consecutive quarters. Other covenants include restrictions on liens, transactions with affiliates, restricted payments, restrictions on mergers and fundamental changes, restrictions on asset sales, debt and investments. Like other MLP bank agreements, EQM receives pro forma EBITDA adjustments for material projects for its leverage calculation.
EQM remains somewhat small yet has increased in size over the last two years. Fitch views the $750 million bank agreement as a reflection of the partnership’s opportunities for growth. Currently, the only debt EQM has is the revolver. Fitch would expect EQM to access the debt capital markets to term out revolver borrowings.
Fitch believes that dropdown of assets from EQT to EQM will continue to be significant for EQM as it seeks to expand its operations, increase distributable cash flow and distributions paid to unitholders.
The most recent dropdown of midstream assets from EQT was the May 2014 acquisition of Jupiter. EQM paid $1.12 billion in cash and $59 million of common and general partnership units for the transaction. The gathering system is located in the Marcellus and has 10-year fixed-fee contracts with EQT. Fitch notes this transaction was approximately twice as large as the prior dropdown, which was for Sunrise Pipeline, LLC. That transaction occurred in July 2013 for a $540 million including $507.5 million in cash, $32.5 million in common and general partnership units. An additional consideration of $110 million was paid to EQT in the first quarter of 2014 following the EQT’s sale of Equitable Gas Company.
In 2014, the partnership forecasts expansion capex in the range of $200 million to $220 million. Maintenance capex is expected to be $17 million to $18 million.
The distribution coverage was 1.5x for the LTM ending with the second quarter of 2014. The partnership’s long-term target for the distribution coverage ratio is 1.1x. Since the IPO in July 2102, distributions to unitholders have increased 40%. EQM plans to increase distributions 29% in 2014 and 22% in 2015.
EQM has two segments, transmission and storage, and gathering. Transmission and storage is the larger segment with transmission accounting for 89% of the first quarter revenues. The largest transmission asset is the Equitrans Transmission system which is a 700-mile FERC regulated interstate pipeline in the Marcellus. In 2013, EQT accounted for 80% of transportation revenues. Storage accounted for 5% of first quarter revenues and its assets include 32 Bcf of natural gas storage capacity. EQT accounted for 61% of 2013’s storage revenues.
In the first quarter of 2014, gathering accounted for 6% of revenues. The gathering segment had a weighted average contract life of 10 years. As of year-end 2013, EQM had 2,300 receipt points with a number of gas producers. EQT accounted for 53% of the 58 BBtu/d of natural gas gathered on the system. While this segment accounted for 6% of first quarter revenues, Fitch expects this to significantly increase following the Jupiter transaction which closed in May.
EQT owns the 2% general partnership (GP) interest and 34.4% the limited partnership (LP) interest of EQM.
- Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Positive rating action is not viewed as likely in the near term given EQM’s significant ties to EQT which is rated ‘BBB-‘; however, a significant increase in third party volumes for a sustained period of time and an increase in size and scale could prompt positive rating action if coupled with low leverage.
- Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
- Material changes in EQM’s strategy to manage the balance sheet conservatively;
- Leverage (defined as debt to adjusted EBITDA) in excess of 4.5x on a sustained basis if its size and scope are not materially larger;
- Inability to grow EBITDA as expected given significant spending (via acquisitions and strategic capex) for growth;
- Significant increases in arrangements which are not fee based which could result in more volatile cash flows.
Additional information is available at ‘www.fitchratings.com’.
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