Fitch Ratings has affirmed Targa Resources Corp.'s (TRC) and Targa Resources Partners LP's (TRP) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB-'.

The Rating Outlook remains Positive.

The year 2023 has witnessed the salutary events that Fitch contemplated when it assigned the Positive Outlook in January 2023. The scale increase and leverage reduction were generally in line with Fitch's expectations. One event that exceeded Fitch's expectations is the reasonable cash flow resilience in the backdrop of sharp decline of natural gas prices. Notwithstanding these good outcomes, Targa is expected to land at the lower end of its guidance due to some integration challenges, supply chain constraint, lower commodity prices, and severe weather conditions.

The Outlook remains Positive due to the increasing fee margin, continued growth, slightly delayed delevering progress and uncertainty around increased focus on shareholder return. The Positive Outlook also reflects Fitch's assumption that Targa manages the distributions and share repurchase within the framework of 40% to 50% of adjusted cash flow from operations and 3.0x-4.0x long-term net leverage target.

Key Rating Drivers

Higher Fee Margin Mitigates Commodity Price Risk: Targa's cash flow benefitted from the fee floors and remained relatively stable in 2023 despite a sharp decline of commodity prices. The company's fee-based margin (inclusive of margin from contracts with a fee floor) is expected to increase to above 80% in 2023, from about approximately 70% in 2022. Fixed fee contracts and percentage-of-proceeds (POP) contracts with fee floors are being added in the core growth region via acquisitions and new commercial wins. Gathering & Processing (G&P) fee-based volumes are expected to increase to approximately 80% from over 50% in 2019, implying lowered business risk over time. While fixed fee contracts insulate Targa from direct commodity price exposure, fee floors in the POP contracts offer downside protection.

Fitch anticipates that the higher fee margin continues to support Targa's profitability should commodity prices remain soft and below the fee floors in 2024. The remaining 15% to 20% are exposed to the commodity price risk and hedged on a rolling basis. Targa currently has 75% of its expected 2024 exposure locked in.

Leverage Under Pressure in the Near Term: Increasing G&P and Logistics and Transportation (L&T) volumes in the near term will support higher growth capex. Under Fitch's price deck, post-dividends FCF turns negative in 2023 and 2024. Fitch forecasts that the company funds 50% higher dividends and share buyback largely with incremental borrowing, pushing the leverage higher to approximately 3.9x by YE 2024. As Targa switches towards a shareholder friendly financial policy, Fitch assumes that the company will manage the spending and return of capital to shareholders within its stated long-term leverage target of 3.0x-4.0x.

Based on Fitch's forecast, leverage is expected to decline to about 3.5x by YE 2025, driven by meaningfully higher EBITDA following the completion of six growth projects in 2024. While Fitch projects the leverage to approach the positive sensitivity of 3.8x in early 2025, expectation of sustained leverage below the positive sensitivity is a key trigger for an upgrade given the company's track record of heavy spending and the renewed commitment to shareholder return.

Volume Exposure: With acreage dedication and some minimum volume commitment (MVCs) under long-term contracts, Targa's system volumes are largely tied to the G&P assets and exposed to volumetric risk. The risk was demonstrated during pandemic when Targa's G&P inlet volumes and L&T volumes declined by approximately 10% and 7%, respectively, in 2Q20 versus 1Q20. Targa's volumes are largely driven by crude oil fundamentals as most natural gas the company handles are associated gas. The price of related natural gas liquids (NGLs) is also more of a function of oil prices, not natural gas prices. Despite lower crude oil prices forecasted in the Fitch price deck, Fitch views the producer fundamentals underlying Targa's main businesses as supportive over the near to medium term.

The increasing G&P concentration in the highly prolific Permian Basin offsets declining volumes from the less robust Anadarko and Bakken Basins, but exposes Targa to outsized events and escalating competition in the region. Fitch anticipates a heightened volumetric risk for Targa in the medium term as midstream companies race for infrastructure development to support robust Permian production growth. In Fitch's view, the risk is partially mitigated by Targa's full NGL value chain infrastructure.

Integrated System Enhances Profitability: The size and breadth of Targa's integrated operations provides Targa with the flexibility to connect natural gas and NGL supply with either export, domestic demand or storage, a valuable solution for its customers in a volatile commodity price environment. The integrated system enhances Targa's pricing flexibility, NGL production economics, and overall competitiveness.

The 2022 acquisitions grow Targa's G&P footprint, particularly in the Permian basin. The Grand Prix acquisition in early 2023 expands the L&T segment, further boosting the scale and supporting the full NGL value chain strategy. Business mix between G&P and L&T was trending back towards 50/50 split from ~60/40 split in 2022, reducing overall volume risk.

Counterparty Diversity: Counterparty risk is a general concern for G&P operators but is relatively limited for Targa. Volumes and margin are supported by contracts and agreements with a diverse set of largely investment grade producers within the producing regions where it operates. Targa does not have any material unsecured concentration with any single high-yield counterparty.

Federal Lands Acreage: The Lucid acquisition included dedicated acres on federal lands, exposing future production to regulatory risks. Approximately 57% of Lucid's acreage dedication is on federal land, which is exposed to regulatory risk. However, much of this land is already permitted, and so bans on new permits may have a lower impact on Lucid's acreage production. Fitch views a ban as unlikely given the current high commodity price environment.

Parent Subsidiary Linkage: There is a parent subsidiary relationship between TRC and the Partnership. Fitch determines TRC's standalone credit profile (SCP) based on consolidated metrics and considers the Partnership's SCP stronger than TRC's. Fitch has applied the stronger subsidiary path. Legal ring fencing is open given the cross guarantees between TRC and the Partnership and the minimal limitations on flows between the entities. Access and control are also open given TRC's 100% ownership interest in the Partnership. TRC is migrating debt from the Partnership to TRC as debt matures. Based on the linkages, Fitch rates both entities on a consolidated credit profile with the same IDRs.

Derivation Summary

Targa is similarly sized to midstream peer ONEOK (BBB/Stable). ONEOK's NGL transportation network has more diverse basin exposure bringing NGLs from the Rockies, the Mid-Continent and the Permian, with more volumes coming from the Rockies and Mid-Continent regions. Post Magellan acquisition, ONEOK further diversifies its business lines into refined products and crude oil. Both companies are volumes exposed with a relatively small percentage of EBITDA supported by minimum volume commitment contracts.

Prior to the Magellan acquisition, ONEOK generated about 90% of its operating margin under fixed-fee contracts. The direct commodity price exposure is expected to increase post the acquisition. Conversely, Targa's commodity price exposure has been trending lower in recent years and accounted for approximately 80% of the margin in 2023. ONEOK's segmental and geographic diversification, in Fitch's view, translates into ONEOK having lower business risk than Targa.

Key Assumptions

The Fitch price deck for oil and natural gas informs the commodity price assumptions;

Base interest expense reflects the Fitch Global Economic Outlook and are assumed to be 4.75% in 2024, and 3.50% in 2025;

2024 and 2025 Capex higher than the trough level post pandemic but on average roughly similar to 2023 level;

Share repurchase and dividend growth in line with management guidance;

No acquisitions or divestitures.

RATING SENSITIVITIES

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

A demonstrated ability to maintain the percentage of fixed-fee and/or hedged gross margin at or above 80% while maintaining leverage below 3.8x on a sustained basis.

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

Leverage expected above 4.8x on a sustained basis;

A significant decline in fixed-fee leading to a gross margin of less than 75% fixed fee without an appropriate significant adjustment in capital structure, specifically a reduction in leverage;

Unfavorable changes in the business mix or financial policies that result in a weaker credit profile.

Liquidity and Debt Structure

Adequate Liquidity: At Sept. 30, 2023, Targa had total liquidity available of approximately $1.76 billion. The components include approximately $1.6 billion of availability on TRC's $2.75 billion senior unsecured revolving credit facility, after accounting for $22.3 million outstanding letter of credit.

Targa also had $139.5 million of cash on the balance sheet and $40 million of borrowing capacity available under the Partnership's $600 million accounts receivable securitization facility. The maturity of this facility was extended to August 29, 2024 and decreased to $600 million from $800 million. TRC's revolver matures in 2027. Proceeds from the $2 billion newly issued notes in November 2023 were used to repay the outstanding borrowings under its commercial paper program and a portion of the term loan facility.

Targa has no near-term maturities with the next maturity due in 2027. As of Sept. 30, 2023, Targa had $810.7 million remaining under its 2023 share repurchase program.

Issuer Profile

Targa is a midstream infrastructure provider with a strategic focus on controlling the full NGL supply chain. It owns G&P assets primarily in the Permian Basin; NGL pipelines connecting to Mont Belvieu, the U.S. NGL hub; and fractionation facilities, storage and NGL export docks in the Gulf Coast.

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.

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