DBRS Confirms Spectra Capital at BBB (high) and R-2 (high), Stable

DBRS has today confirmed the Unsecured Debentures and Commercial Paper ratings of Spectra Energy Capital, LLC (Spectra Capital or the Company) at BBB (high) and R-2 (high), respectively, both with Stable trends. The current ratings incorporate DBRS’s expectation that Spectra Capital’s significant capex program (projected to be $2.0 billion in 2011, including $1.3 billion spent through September 30, 2011, and in excess of $1.0 billion of growth capex annually through 2015), combined with selective acquisitions (including the July 1, 2011, acquisition of Big Sandy Pipeline, LLC by the Company’s 64%-owned subsidiary, Spectra Energy Partners, LP for $390 million), will result in negative free cash flows and pressure its credit ratios, as much of the financing will come from increased long-term debt.

While Spectra Capital’s capex program is substantial, the spending is allocated to low-risk transmission, gathering and processing and storage projects, which will continue to support its business risk profile. However, the Company’s DCP Midstream, LLC (DCP, 50%-owned) and Empress NGL Marketing (Empress) operations, both of which own natural gas gathering and processing operations, provide a more volatile source of earnings and cash flow as a result of commodity price and fractionation spread risk. Despite lower capex, the Company had deteriorating credit metrics (cash flow-to-debt and EBITDA interest coverage of 14% and 3.6 times, respectively) and a very high dividend payout ratio (84%) in 2009 compared with 2008, largely due to much lower contributions from DCP.

Spectra Capital’s credit metrics improved in 2010 and in the nine months ending September 30, 2011 (9M 2011, during which the cash flow-to-debt, EBITDA interest coverage and dividend payout ratio were 19%, 4.6 times and 60%, respectively) as higher earnings and cash flow from expansion projects and acquisitions, as well as higher contributions from DCP and Empress, offset the impact of rising debt to finance free cash flow deficits. DBRS expects the Company’s credit metrics to remain relatively volatile over the medium term, mainly due to net free cash flow deficits and variable results from DCP. In the absence of significant dividend income from its equity affiliates, especially DCP, Spectra Capital’s credit metrics are relatively weak for the current ratings, although this is partly mitigated by the improved business risk profile expected over time.

In addition, Spectra Capital’s Distribution segment earnings are exposed to volume risk, which is sensitive to changes in weather, economic conditions and gas prices. The Company’s Western Canada Transmission & Processing segment also faces some volume risk at B.C. Field Services and Spectra Energy Facilities L.P. (Midstream) and commodity price and/or fractionation spread risk at Empress. EBIT from both segments benefits from a lower CAD/USD exchange rate. U.S. Transmission faces significant competition for supply and end-user markets.

The above-noted factors are partly mitigated by the following factors:

(1) Spectra Capital has a good business risk profile, generating nearly 80% of its segment EBIT from low-risk, mostly regulated operations since the beginning of 2009, compared with 61% of segment EBIT in 2008. This factor somewhat offsets relatively high balance sheet leverage (debt-to-total capital of 55.5% at September 30, 2011), partly due to the one-third and 40% weighting of the Canadian regulated natural gas transmission and distribution operations with respect to EBIT and long-term debt, respectively (which have higher debt components than the U.S. regulated operations). The balance of Spectra Capital’s EBIT generation (approximately 24% for the 12 months ending September 30, 2011) comes from its interests in DCP and Empress.

(2) The Company’s direct debt ($4.5 billion as at September 30, 2011) accounted for 40% of its consolidated total debt, compared with $3.7 billion of direct debt (37% of consolidated total debt) as at December 31, 2009. Virtually all of the Company’s remaining $6.7 billion of consolidated total debt is held at subsidiaries that are engaged in self-supporting and stable natural gas transmission and distribution operations. Spectra Capital’s non-consolidated credit metrics have improved from 2009 and 9M 2010 levels as higher equity earnings from expansion projects and DCP have offset the impact of higher debt. Consequently, non-consolidated credit metrics have also been relatively volatile, a trend that is likely to continue over the medium term. In the absence of significant equity earnings from DCP, Spectra Capital’s non-consolidated credit metrics are relatively weak for the current ratings, although this is to some extent mitigated by an improving business risk profile.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating North American Pipeline and Diversified Energy Companies, which can be found on our website under Methodologies.