DCP MIDSTREAM, LP
Fitch Ratings has affirmed
In addition, Fitch has affirmed
Fitch views PSX's increased ownership as credit neutral for DCP. PSX's acquisition integrates DCP's NGL footprint into its wellhead to water strategy. PSX will have operational control, but there is no evidence of increased parent support for DCP. While Fitch has not changed its rating now, it will look to factors that may cause closer alignment between PSX and DCP, such as execution of the integrated strategy that Fitch believes would materially increase cash flow from DCP or trigger a significant capital investment from PSX.
Fitch's ratings reflect DCP's declining leverage, diverse asset footprint and mostly investment grade customers, offset by volume risk and higher commodity price risk relative to midstream peers.
Key Rating Drivers
Phillips 66 Majority Ownership: PSX and
Fitch rates DCP on a standalone basis from its sponsors, with no explicit notching from its parent companies' ratings; however, the ratings reflect that its owners have been and are likely to remain supportive of its operating and credit profile. In the past, ENB and PSX have exhibited a willingness to forgo dividends. This support was most recently demonstrated by the approval of the
Scale and Scope of Operations: DCP's ratings reflect the size, scale and diversity of its asset base. Also incorporated, is its position as a large producer of natural gas liquids (NGLs) and processor of natural gas. The partnership has a robust operating presence in most of the key production regions within the
The size and breadth of DCP's operations allow it to offer its customers end-to-end gathering, processing, storage and transportation solutions, giving it a competitive advantage within the regions where they have significant scale. Excess capacity on several of DCP's systems provide opportunities for volume growth with incremental optimization expenses in higher margin regions to improve utilization.
Volumetric and Commodity Price Exposure: DCP's ratings reflect its exposure to volumetric and commodity price risks associated with the domestic production and demand for natural gas and NGLs. Approximately 50% of DCP's gross margin is provided from the logistics and marketing (L&M) segment, which generally provides fee-based cash flows with exposure to volumetric-risk.
Gathering and processing (G&P, approximately 50% of gross margin) contracts are largely backed by dedicated acreage and are a mix of non-commodity sensitive fee-based contracts and commodity sensitive percent-of-proceeds and percent-of-liquids contracts. DCP is expected to further benefit from its unhedged commodity-price exposure in 2H22, as higher commodity prices spur increasing production and DCP completes additional well connects in the
As of 2Q22, approximately 70% of gross margin is fee-based, and DCP has hedged 13% of the remaining margin. The company has taken advantage of favorable pricing across associated hydrocarbons and added hedges that reduce its sensitivity to a large drop in prices. DCP's hedging program contributes to a steady cash flow profile but also exposes it to longer-term hedge roll-over and commodity price risks. The company is well hedged for each quarter in 2022.
Improving EBITDA Drives Leverage Decline: Fitch expects leverage to decline to the 3.0x-3.3x range in 2022 and 2023, driven by improving G&P volumes in DCP's key DJ and
On the L&M side of the business DCP is benefitting from third-party shippers shifting into ethane recovery and is expected to see increased throughput in 2H22. As the Fitch price deck returns closer to mid-cycle leverage in the outer forecast years, leverage is expected to moderate to 3.6x-3.8x range.
Capital Allocation Strategy: Management has reached their targeted leverage metric per their bank covenant calculation as of 2Q22 LTM financials, and is expected to continue to produce excess FCF throughout Fitch's forecast period. Modest growth capex is expected to continue to fund bolt-on opportunities in their G&P business in the DJ and Permian basin footprints. Incremental optimization and investment projects will be aimed at improving asset utilization and added connectivity to
Parent Subsidiary Linkage: Fitch now assesses a parent subsidiary relationship between PSX and DCP, reflecting the change in control under the new JV ownership structure. Fitch believes PSX has a stronger credit standalone credit profile (SCP). As such, Fitch follows the stronger parent path to determine DCP's ratings. Legal incentive is considered low as there are no guarantees or cross-default provisions.
Strategic and operational incentives are considered low as the incremental contribution DCP makes to PSX remains small with no clearly defined plans to grow current operations. Additionally, there is no evidence of avoidance costs as DCP and PSX currently have contractual agreements. Due to the aforementioned rating considerations, Fitch rates DCP on a standalone basis and does not receive any uplift in the rating from PSX.
There is a parent subsidiary relationship between DCP and
Derivation Summary
DCP's ratings reflect its favorable size, scale, geographic and business line diversity within the NGL production and transportation and natural gas G&P space. The ratings recognize DCP's greater exposure to commodity prices than other midstream peers, with approximately 70% of gross margin supported by fixed-fee contracts. This commodity price exposure has been partially mitigated in the near term through DCP's use of hedges for its NGL, natural gas and crude oil price exposure, pushing the percentage of gross margin, either fixed-fee or hedged, up to 83% as of 2Q22. This helps DCP's cash flow stability, but exposes it to longer-term hedge roll-over and commodity price risks.
DCP is slightly smaller in terms of EBITDA generation but more geographically diversified than NGL focused midstream peer
Fitch expects DCP's leverage to be around 3.0x-3.3x through 2023. Targa's leverage is expected to be slightly higher in the range between 3.4x-3.6x in 2023. Both companies' leverage position them well within the 'BBB-' rating category.
Key Assumptions
Fitch's Key Assumptions Within The Rating Case for the Issuer:
Base case WTI oil price deck
Growth and sustainable capex in line with management's guidance;
No significant acquisitions are included in the forecast;
Upcoming debt maturities to be repaid with FCF;
PSX is successful in acquiring the outstanding public units of DCP.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
A demonstrated ability to maintain the percentage of fixed-fee or hedged gross margin at or above 80% while maintaining leverage (total debt with equity credit/operating EBITDA) below 3.5x for a sustained period could lead to a positive rating action;
Evidence of DCP becoming a material or growing component of PSX;
Meaningful increase in scale.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Leverage expected above 4.5x on a sustained basis and may result in at least a one-notch downgrade;
A significant decline in fixed-fee or hedged commodity leading to gross margin less than 70% fixed fee or hedged without an appropriate significant adjustment in capital structure, specifically a reduction in leverage, would likely lead to at least a one-notch downgrade;
A significant change in the ownership support structure from GP owners to the consolidated entity particularly with regard to the GP position on commodity price exposure, distribution policies and capital structure at DCP, the operating partnership.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
Liquidity and Debt Structure
Adequate Liquidity: As of
Maturities are manageable. The nearest maturity is the
Issuer Profile
DCP is a midstream energy company that is a large producer and marketer of NGLs, and processor of natural gas with operations in the
Summary of Financial Adjustments
Fitch applies 50% equity credit to DCP's junior subordinated notes and 0% equity credit to DCP's existing preferred equity in Fitch's forecasts. Previously 50% equity credit was given to DCP's preferred units but due to lack of established permanence they now receive 0%. Fitch typically adjusts master limited partnership EBITDA to exclude equity interest in earnings from unconsolidated affiliates but includes cash distributions from unconsolidated affiliates.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
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