Fitch Ratings has affirmed DT Midstream, Inc.'s (DTM) 'BB+' Long-Term Issuer Default Rating (IDR). Fitch has also affirmed the senior secured loan and note ratings and the senior unsecured note ratings at 'BBB-'/'RR1' and 'BB+'/'RR4', respectively.

The Rating Outlook has been revised to Positive from Stable.

The Positive Outlook reflects DTM's strong performance and lower leverage in 2022 and Fitch's expectation of continued momentum in the near term. It also reflects the improving credit profile of its major counterparties.

The rating reflects long term contracts and growing scale assuring stable cash flows and low leverage, limited by exposure to non-investment grade counterparties. Fitch expects leverage to remain at approximately 4.0x in the forecast period while DTM balances its growth needs and leverage target. DTM's exposure to low rated counterparties remains a limiting factor for the rating.

Key Rating Drivers

Low Leverage: Since Dec. 31, 2022, leverage has been on a steady decline, mainly as a result of EBITDA growth. Fitch forecasts the leverage to drop to approximately 4.0x by 2023 (Fitch leverage is the ratio of (a) consolidated debt over; and (b) EBITDA, with EBITDA using distributions from off-balance joint ventures (of which DTM has a few, some of which have leverage). Fitch calculated that leverage was 4.2x in 2022 (note: management calculates leverage differently than Fitch). After 2023, Fitch anticipates DTM to post leverage of 4.0x or below in most years (with some years potentially slightly exceeding 4.0x due to either mid-year acquisitions or capex projects lasting longer than 9 months-12 months).

Counterparty Exposure: Despite a diversified customer base of producers, utility companies, and marketers, DTM remains exposed to counterparty risk. Southwestern Energy Company (SWN; BB+/Positive) generated about 65% of revenues with a significant portion of the contracts containing minimum volume commitment (MVC) in 2022. SWN is one of the largest natural gas producers in the U.S. with a footprint in the Appalachia and Haynesville basins. SWN's credit profile has improved in recent years, which is credit positive in Fitch's view.

Fitch anticipates that the concentration in counterparties will remain, although the takeaway capacity constraint in Appalachia is driving re-contracting and addition of new customers, and the strong liquefied natural gas (LNG) demand in the Gulf Coast is driving capacity expansion in the Haynesville assets (Blue Union and LEAP). We also noted that Nexus joint venture (JV) in Appalachia (where DTM owns 50% interest) is shifting towards largely demand-pull customers with the addition of utility customers.

Cash Flow Assurance: DTM's revenues are predominantly fee based with a significant percentage, over 70% in 2022, coming from MVCs and demand charges, lowering volume risk. Cash flow assurance will remain high in the near term, but the payments from MVCs and demand charges will step down over time, increasing cash flow volatility. DTM's contracts have a weighted average contract life of approximately nine years. Fitch believes DTM will manage the contract maturities and pair gathering commitments with firm transportation agreements to lower the volume risk in the gathering business.

Assets Base: The company's assets are located in two highly economic natural gas basin, the Marcellus/Utica and the Haynesville, which account for approximately 50% of total US dry gas production. In 2022, approximately 65% of EBITDA was from the Marcellus/Utica, 30% from the Haynesville and 5% from other regions. DTM's focus is on dry gas and its transportation to the Northeast and Gulf Coast, with smaller amounts delivered to the Midwest and eastern Canada.

Given the difficult regulatory process facing construction of new pipelines, especially in the Appalachian basin, DTM benefits from the high demand of its pipeline assets, including notable stake in JVs. Its assets are also well positioned to serve the growing needs of LNG export facilities located in the Gulf Coast. Fitch anticipates that DTM will continue to leverage both organic growth and opportunistic acquisitions to expand its assets in these basins.

Scale and Scope of Operations: With an adjusted EBITDA exceeding $800 million, DTM's ratings benefit from its size and scale. Approximately 43% of DTM's 2022's adjusted EBITDA was from the gathering segment and 57% from the pipeline segment (of which about 40% was cash distributions from four pipeline joint ventures).

Given the acquisition of additional interest in Millennium Pipeline, success in signing demand-pull contracts, and an expansion of the Louisiana Energy Access Pipeline (LEAP), Fitch anticipates the pipeline segment, including the JVs, will grow faster than the gathering segment in the near term and contribute approximately 60% of adjusted EBITDA in 2023. The increasing weight of pipeline business adds additional stability to the cash flow as this segment is generally less volatile than the gathering business.

Derivation Summary

DTM is the midstream segment spun from DTE Energy Company (DTE; IDR BBB/Stable) in 2021. It is a platform of about 1,000-mile system of gathering pipelines and 1,200 miles of pipeline assets that connect key markets in the Northeast U.S., Gulf Coast regions, Midwest U.S., and Eastern Canada to production in the largest and most economic dry gas basins in the United States, the Marcellus/Utica and Haynesville Basins.

A comparable for DTM is Kinetik Holdings LP (Kinetik; BB+/Positive) which operates in the Permian. Both companies have similar amounts of EBITDA, and both have large presence in their respective operating regions.

Revenues at both companies are predominantly fee-based. Compared to DTM, Kinetik is more gathering and processing focused (approximately 60% of run-rate EBITDA), a business activity which Fitch regards as generally higher-risk than the long-distance transport of hydrocarbons. An offsetting factor is Kinetik's better counterparty exposure with approximately two thirds of its diversified customer base being investment grade customers, when isolating long-term take-or-pay payments. DTM's most salient take-or-pay exposure is to a 'BB+' rated company with a positive outlook.

Fitch calculated Kinetik's FY22 leverage to be in line with DTM's at approximately 4.2x and is trending below 4.0x level in the forecast period. Kinetic is committed to a lower long-term leverage target of 3.5x, balancing its slightly higher business risk compared to DTM.

The companies are rated the same as they are similar on most features.

Key Assumptions

A Fitch price deck of Henry Hub natural gas prices: $3.0 (USD/mcf) in 2023; $3.5 in 2024, $3.0 in 2025 and $2.75 per thousand cubic feet over the long term;

Revenues have mid-single digit organic growth in the near term;

Phase 1 of LEAP expansion is online in Q4 2024;

Capital spending and dividends growth generally in line with management guidance;

The company generate positive free cash flow (which may be directed for opportunistic acquisitions, returns for shareholders, or debt reduction).

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

EBITDA Leverage below 4.0x, together with an expectation that the leverage can be sustained below 4.0x;

Improvement in the credit quality of the major counterparties.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Leverage (total debt with equity credit to operating EBITDA) be at or above 5.0x on a sustained basis;

A significant decline in MVCs/demand charges beyond Fitch's forecast period may require lower leverage for ratings to remain unchanged;

Acquisitions or significant increase in capex targeted towards higher business risk projects.

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 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity Expected: As of March 31, 2023, DTM had $95 million of cash on the balance sheet. Fitch believes the revolving credit facility, with $551 million available net of the $39 million of LOCs outstanding, provides DTM with sufficient liquidity through the forecast period. DTM reduced its exposure to variable rate obligations, with about 23% of total debt bearing variable rate.

Issuer Profile

DTM has a platform of gathering assets and pipeline assets, wholly owned and through JVs, that connect dry gas to demand centers in the Midwestern U.S., Eastern Canada, Northeastern U.S. and Gulf Coast regions to the Marcellus/Utica and Haynesville basins in the Appalachian and Gulf Coast Basins.

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

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

(C) 2023 Electronic News Publishing, source ENP Newswire