DBRS Confirms Pembina Pipeline Corporation at BBB (high), Stable Trend

DBRS has today confirmed the ratings of the Senior Unsecured Notes and 7.38% Senior Secured Notes of Pembina Pipeline Corporation (Pembina or the Company) at BBB (high), with Stable trends. These two ratings were equalized on November 3, 2009, with the rating of the Senior Unsecured Notes upgraded to BBB (high) from BBB, noting the very small amount of secured notes that ranked ahead of the unsecured notes and the expectation that the Company would not issue any more secured debt in the future. The rating confirmations follow the successful conversion of Pembina Pipeline Income Fund (the Trust) to the Company (previously the Trust’s 100%-owned holding company) under a Plan of Arrangement completed on October 1, 2010.

The conversion of the Trust to a taxable corporation structure on October 1, 2010, did not affect the Company’s credit ratings as it will continue to focus on steadily growing its business, while keeping its credit metrics within the parameters of the current rating categories. Certain taxation considerations could reduce the Company’s taxes payable until 2015.

The Company continues to maintain relatively solid credit metrics and stable operations with substantial growth prospects, particularly in oil sands and heavy oil (OSHO) infrastructure expansions. The underpinnings are the long-lived assets, supported largely by long-term contracts or regulated returns, which represented about 50% of EBITDA for the 12 months ending June 30, 2010 (LTM). DBRS estimates that this could rise to more than 55% when the Nipisi and Mitsue pipeline projects (Nipisi and Mitsue) are complete, which is expected in mid-2011, providing an estimated $45 million of net operating income per year, similar to the Horizon Pipeline (Horizon), in service in late 2009. This should partly mitigate the growing midstream and gas services segments (34% of EBITDA), the latter set up for the Cutbank Complex gas gathering and processing facilities (Cutbank) acquired in June 2009, which have certain indirect exposure to commodity prices, although it is considered manageable.

Furthermore, DBRS expects the Company to address its relatively high balance sheet leverage (47% at June 30, 2010, versus 40% in 2006) during its growth phase with additional equity or quasi-equity instruments over time. Pembina suspended its reinstituted distribution reinvestment plan (DRIP) in April 2010, which was previously used to partly fund Nipisi and Mitsue. In addition, as the Company intends to be a high yielding corporation, post-conversion on October 1, 2010 (with more details mentioned below), it will continue to pay out almost all its operating cash flow during its higher capital spending years to 2011/2012, meaning that any major expansions and acquisitions would require external funding similar to when it was operated by its parent, Pembina Pipeline Income Fund, under a trust structure. However, the payout ratio should decline below 90% by 2011, reducing further thereafter, given the full impact of Nipisi and Mitsue. Annualized cash distributions per unit through the Trust increased to $1.56 in 2009, up 46% since 2005. The Company intends to continue with the distributions in the form of dividends to 2013 and will likely review its dividend policies prior to 2013 to be more in line with its corporate peers.

Going forward, Nipisi and Mitsue will further enhance Pembina’s diversification and competitive position in the growing OSHO business (24% EBITDA in 2009), which at present primarily includes the Syncrude Pipeline (estimated 9% EBITDA) and Horizon (14%). The new projects are mostly supported by long-term contracts with two anchor shippers, Cenovus Energy Inc. (rated A (low)) and Canadian Natural Resources Limited (rated BBB (high)). The contracts are designed to provide for full recovery of operating expenses proportionate to capacity under contract, providing earnings and cash flow stability. The Nipisi project will initially provide 120,000 barrels per day (b/d) of combined diluent and heavy oil transportation in northwestern Alberta (expandable to 222,000 b/d). The estimated cost of $440 million (about $68 million spent in 2009) for Nipisi and Mitsue will likely consume about $152 million of the $240 million capex in 2010, with the remaining $220 million slated for 2011. Given the Company’s virtually 100% payout of operating cash flow, as mentioned above, incremental debt is expected in the near term. However, the Company maintains adequate liquidity through its $600 million of credit facilities ($328 million undrawn at June 30, 2010) versus $88 million debt due in December 2010, including $30 million of convertible debentures, which will be converted at maturity. The Company’s cash flow-to-debt ratio, while declined in 2008 and 2009, has recovered and should remain solid (0.24 times for LTM) relative to its peers, with still strong EBITDA-to-interest coverage (5.2 times) during the Company’s higher capital spending years to 2011.

The Cutbank operations are supported by contracts for more than 50% of the associated capacity to 2014, with these contracts structured on a fee-for-service basis and all operating costs flowing through to its customers, providing Pembina with a measure of cash flow stability. However, there will still be some throughput risk, although this is considered manageable. The expanding midstream operation could introduce more volatility into the Company, although this is mostly minimized through contractual arrangements with the counterparties, who are also shippers on the Company’s feeder pipelines.

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

The applicable methodology is Rating North American Energy Utilities (Electric, Natural Gas and Pipelines), which can be found on our website under Methodologies.