Morningstar DBRS Confirms Inter Pipeline Ltd.’s Issuer Rating at BBB (low) and Fixed-to-Floating Rate Subordinated Notes at BB, Changes Trends to Negative from Stable

DBRS Limited (Morningstar DBRS) confirmed Inter Pipeline Ltd.’s (IPL or the Company) Issuer Rating and Senior Unsecured Notes rating at BBB (low) and its Fixed-to-Floating Rate Subordinated Notes at BB. At the same time Morningstar DBRS has changed all trends to Negative from Stable.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations reflect the Company’s strong business-risk profile underpinned by contracted cash flows and a diversified asset base with a competitive position. The challenges to the rating include the start-up risk at the Heartland Petrochemical Complex (HPC), commodity price and volume risk, and weaker credit metrics through the ramp-up at HPC. The change in trend to Negative from Stable follows the Company’s announcement that because of operational constraints, production at the propane dehydrogenation (PDH) facility will likely remain below design capacity in H1 2024 before ramping up to planned run rate production in H2 2024. Consequently, Morningstar DBRS expects the improvement in the Company’s modified consolidated cash flow-to-debt ratio to be around 15% (Target Credit Metric; treating Inter Pipeline (Corridor) Inc. (rated A (low) with a Stable trend by Morningstar DBRS) as an equity investment), which is currently weak, to be delayed at least into 2025 and is subject to successful resolution to the operating constraints at HPC.

CREDIT RATING DRIVERS
Morningstar DBRS could downgrade the rating by a notch if production and EBITDA at HPC does not ramp up through H2 2024/2025 and there is no progress toward Morningstar DBRS’ Target Credit Metric. Morningstar DBRS could change the trend back to Stable if production at HPC after the maintenance activity is consistently closer to design capacity, and the run rate EBITDA at HPC improves through 2025 to support the Target Credit Metric. Morningstar DBRS could also change the trend back to Stable if IPL reduces gross debt such that there is a clear line of sight to achieving the Target Credit Metric even if performance at HPC is below expectations.

EARNINGS OUTLOOK
Morningstar DBRS expects IPL’s earnings in 2024 to be higher than in 2023 because of the ramp-up in production at HPC, a full year contribution from the Alberta Petrochemicals Incentive Program (APIP) grant of $136 million, and a modestly improved outlook for the Marketing segment. However, the expected improvement is less compared with Morningstar DBRS’ assumption at the time of the last rating confirmation on November 7, 2023, because of the delay in ramp-up in output at HPC. Beyond 2024, Morningstar DBRS expects earnings and cash flow at the Company’s Transportation and Facilities segment to grow based on secured projects and optimization initiatives. IPL’s sustaining/growth capital expenditure (capex) requirements after 2024 are modest relative to its cash flow, and Morningstar DBRS expects IPL to generate a significant free cash flow (FCF; i.e., cash flow after capex) surplus even if earnings from HPC are below expectations.

FINANCIAL OUTLOOK
Given the delay at HPC, Morningstar DBRS expects IPL’s credit metrics to remain weak in 2024 with modified consolidated cash flow-to-debt ratio at around 10%. Morningstar DBRS expects IPL to maintain its Target Credit Metric once HPC is fully operational. Morningstar DBRS expects Brookfield Infrastructure Partners L.P. and its institutional partners (together, Brookfield Infrastructure) to be prudent with distributions until HPC is fully operational. IPL has sufficient liquidity available under its credit facilities, and refinancing risk remains manageable. At December 31, 2023, IPL had access to committed credit facilities totaling $1.3 billion, which was undrawn, and a cash balance of $275.8 million.

CREDIT RATING RATIONALE
Morningstar DBRS had previously noted that material delays at HPC that could disrupt the assumption of 2024 being a full year of operation could have a negative impact on the credit ratings. The latest operating constraints at the PDH plant will delay full-year production at HPC beyond 2024 as the Company has to operate the PDH plant below design capacity until it commences maintenance activity in Q2 2024, which is expected to last for most of the quarter. The Negative trend acknowledges the risk that the remediation measures may not be successful, and ramp-up of production and the improvement in credit metrics may be delayed beyond 2025. Morningstar DBRS recognizes the possibility of modest delays during the commissioning of a large petrochemical plant. However, this is the second material delay at the PDH plant after the repairs at the facility in Q2 2023. While all the take-or-pay contracts and the APIP grant have commenced at HPC, given the delays, HPC is yet to generate EBITDA on a run rate basis consistent with the long-term Morningstar DBRS annual forecast of approximately $300 million. At the Company’s current level of debt, a successful ramp-up to design capacity and annualized EBITDA at HPC in line with Morningstar DBRS forecast are essential for the Company to achieve the Target Credit Metric.

Morningstar DBRS acknowledges that Brookfield Infrastructure is committed to maintaining IPL’s BBB (low) rating, and the expected FCF surplus in 2025 and beyond will provide it with an opportunity to deleverage. However, the quantum of deleveraging required at IPL to achieve the Target Credit Metric in the event of further delays at HPC is material and will require Brookfield Infrastructure to forego distributions.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Environmental (E) Factors
There were no Environmental factor(s) that had a relevant or significant effect on the credit analysis.

Social (S) Factors
There were no Social factor(s) that had a relevant or significant effect on the credit analysis.

Governance (G) Factors
There were no Governance factor(s) that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)

(A) Weighting of BRA Factors
In the analysis of IPL, the BRA factors listed in the Pipeline and Midstream Energy Industry are considered in the order of importance contemplated in the methodology.

In the analysis of IPL, the following BRA factors listed in the Oil and Gas and Oilfield Services Industries are considered more important, Operating Efficiency, Ability to Withstand Market Volatility, and Capital Intensity.

(B) Weighting of FRA Factors
In the analysis of IPL, the following FRA factors listed in the Pipeline and Midstream Energy Industry are considered more important, Cash flow-to-debt and EBIT Interest Coverage.

In the analysis of IPL, the FRA factors listed in the Oil and Gas and Oilfield Services Industries are considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of IPL, the BRA listed in the Pipeline and Midstream Energy Industry carries greater weight than the FRA.

In the analysis of IPL, the BRA and the FRAs listed in the Oil and Gas and Oilfield Services Industries carry approximately equal weight.

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

Morningstar DBRS applied the following principal methodologies:

-- Global Methodology for Rating Companies in the Oil and Gas and Oilfield Services Industries (August 16, 2023),
https://dbrs.morningstar.com/research/419228
-- Global Methodology for Rating Companies in the Pipeline and Midstream Energy Industry (November 7, 2023),
https://dbrs.morningstar.com/research/422993

The following methodology has also been applied:

-- DBRS Morningstar Global Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (October 19, 2023),
https://dbrs.morningstar.com/research/422134

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/397223.

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 [email protected].

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

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

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at [email protected].

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