DBRS Morningstar Places All Ratings of Pembina Pipeline Corporation Under Review With Developing Implications

DBRS Limited (DBRS Morningstar) placed all the ratings of Pembina Pipeline Corporation (Pembina or the Company) Under Review with Developing Implications as follows:

-- Issuer Rating, BBB (high), Under Review with Developing Implications
-- Senior Unsecured Notes, BBB (high), Under Review with Developing Implications
-- Preferred Shares, Pfd-3 (high), Under Review with Developing Implications
-- Fixed-to-Fixed Rate Subordinated Notes, BBB (low), Under Review with Developing Implications

DBRS Morningstar’s rating actions follow the Company’s announcement that it has entered into an agreement with Inter Pipeline Ltd. (IPL; rated BBB with a Stable trend by DBRS Morningstar) for Pembina to acquire all the issued and outstanding shares of IPL in a share-for-share transaction (Acquisition), which values IPL common shares at approximately $8.3 billion or $19.45 per IPL’s share, based on the closing price of Pembina’s common share on May 31, 2021 ($17.55). Pembina will also assume IPL’s approximate $5.0 billion outstanding debt (excluding the debt at Inter Pipeline (Corridor)). The Acquisition is expected to close in the fourth quarter of 2021, subject to the shareholder approvals (both Pembina’s and IPL’s), regulatory approvals, as well as the approval of the Court of Queen’s Bench of Alberta.

DBRS Morningstar expects that the proposed Acquisition, if completed, will significantly improve Pembina’s size and operational scale as follows: (1) Pembina’s pipeline capacity will increase by approximately 100% from 3.1 million barrels of oil equivalent per day (MMboe/d) to 6.2 MMboe/d; processing capacity will increase by approximately 40% to 8.8 billion cubic feet per day. In addition, fractionation facility and storage capacity will also increase meaningfully to 390,000 barrels per day (bpd) and 38 million barrels, respectively. Following the Acquisition, Pembina will become one of the largest energy infrastructure companies in Canada with a significant diversified and integrated asset base that can support an extensive value chain for natural gas, natural gas liquids, and crude oil (conventional and heavy oil), from wellhead to end user. (2) The Acquisition will result in greater vertical integration and wider ranges of customer service offerings. In addition, DBRS Morningstar notes that Pembina expects the Acquisition to realize pretax synergies in the range of $150 million to $200 million annually.

However, DBRS Morningstar notes that currently IPL has a larger exposure to commodity price risk than Pembina (measured on a percentage of EBITDA basis) because of its Heartland Petrochemical Complex (HPC), which is a propane dehydrogenation and polypropylene production complex. However, the Acquisition will result in greater supply risk mitigation as Pembina is the industry leader of propane supply with 60,000 bpd. IPL recently announced that it has obtained approximately 60% of HPC’s production capacity under long-term, take-or-pay contracts with the average length of nine years, significantly reducing exposure to commodity price risk. HPC is expected to be in service in early 2022 and fully operational in 2023. DBRS Morningstar expects that HPC’s capacity under contracts will reach 80% when it is fully operational.

DBRS Morningstar does not expect the Acquisition to have a material impact on Pembina’s financial profile. However, currently, Pembina’s credit metrics are stronger than IPL’s. Following the Acquisition, DBRS Morningstar expects Pembina’s post-Acquisition credit metrics to weaken modestly from the current level but remain strong for the combined entity.

In 2020, Pembina and IPL reported the flowing key financial data:

PEMBINA
EBITDA: $2,840 million
Cash flow: $2,387 million
Total debt at December 31, 2020: $10.9 billion

IPL
EBITDA: $968 million
Cash flow: $762 million
Total debt at December 31, 2020: $4.9 billion (excluding debt at Inter Pipeline (Corridor))

The Under Review with Developing Implications rating actions reflect the uncertainties associated with the following:

(1) In the announcement, Pembina mentions that the combination of HPC and Pembina will eliminate long-term supply risk for HPC. It also mentions that the Acquisition will create the possibility of a second such facility. DBRS Morningstar believes that the second facility, similar to HPC, will create significant potential exposure to construction and commodity price risk. At the time of the closing of the Acquisition, DBRS Morningstar will assess the likelihood of this announcement and will provide a rating opinion accordingly.

(2) DBRS Morningstar expects that Pembina will assume IPL’s debt. However, DBRS Morningstar needs to review the debt documents after the completion of the Acquisition to ensure IPL’s senior debt will rank equally with the senior debt issued by Pembina.

(3) DBRS Morningstar needs to assess Pembina’s future strategy and financial forecast over the next five years following the Acquisition, including capital expenditures, dividend policy, potential asset dispositions, financing plans, cash flow-to-debt target or debt/EDITDA target, contractual arrangements, the strength of counterparties, and the target of fee-for-service, cost-of-service, and take-or-pay contracts in terms of the percentage of EBITDA.

DBRS Morningstar believes that with the Acquisition there is a potential improvement of size, operational scale, infrastructural and operational integration, and diversification for Pembina’s business risk profile. However, this is significantly offset by potential exposure to commodity price risk. Given Pembina’s currently strong credit metrics, DBRS Morningstar expects the Company to remain resilient in coping with market volatility in the near to medium term; however, DBRS Morningstar could take a negative rating action if the Company’s post-Acquisition credit metrics weaken materially from the current level on a sustained basis and/or if its business risk profile deteriorates significantly, particularly its future exposure to commodity price risk rising to above 20% of EBITDA on a long-term basis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodologies are Rating Companies in the Pipeline and Diversified Energy Industry (November 19, 2020; https://www.dbrsmorningstar.com/research/370267) and DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 2, 2020; https://www.dbrsmorningstar.com/research/369165), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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 under Related Documents or by contacting us at info@dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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