DBRS Comments on Pembina Pipeline Corporation’s Proposed Acquisition of Kinder Morgan Canada and Cochin Pipeline

DBRS Limited (DBRS) notes that on August 21, 2019, Pembina Pipeline Corporation (Pembina or the Company; rated BBB with a Stable trend by DBRS) announced that it had entered into agreements to acquire Kinder Morgan Canada Limited (KML; Preferred Shares rated Pfd-3 with a Stable trend by DBRS) (the Corporate Acquisition) and the U.S. portion of the Cochin Pipeline system (Cochin USA) from Kinder Morgan, Inc. (KMI; rated BBB with a Stable trend by DBRS) (the Cochin Acquisition) for a total of approximately $4.35 billion (the Transaction). The Transaction values KML at approximately $2.3 billion, or $15.02 per share, based on an all-share exchange ratio of 0.3068 and Pembina’s 30-day volume weighted-average price; and Cochin USA at approximately $2.05 billion for cash consideration, which will be temporarily funded through Pembina’s existing credit facility and a $1.0 billion term loan facility that has been arranged to support the financing.

The boards of directors of Pembina and KML have unanimously approved the Corporate Acquisition, which is expected to close late in the first half of 2020, subject to (1) the approval of at least 66 2/3 per cent of the holders of KML’s Restricted Voting Shares and Special Voting Shares, voting together as a single class, and a majority of the holders of Restricted Voting Shares; (2) approval of the Court of Queen’s Bench of Alberta; (3) certain regulatory approvals in Canada and the United States; and (4) other customary conditions.

As part of the agreements, Pembina has agreed to acquire all of the outstanding membership interests in Kinder Morgan Cochin LLC, the owner of the U.S. portion of the Cochin Pipeline, for USD 1.546 billion in cash (approximately $2.05 billion). The Cochin Acquisition is expected to close late in the first half 2020, subject to certain regulatory approvals in Canada and in the United States, as well as other customary closing conditions.

Overview of Acquired Assets

(1) Cochin Pipeline: This pipeline system transports condensates from Riga, Michigan, to Fort Saskatchewan, Alberta. The Cochin Pipeline has a capacity of 110,000 barrels per day (b/d) on the Canadian portion and 95,000 b/d on the U.S. portion, of which 85,000 b/d are under long-term take-or-pay contracts until 2024 (Shipper Contracts). The Shipper Contracts are with investment-grade counterparties. Upon closing, Pembina will own 100% of the Cochin Pipeline (both the U.S. and the Canadian portions).

(2) Storage assets: The liquid tank storage assets are primarily under long-term take-or-pay contracts with an average remaining term of six years. The assets consist of (1) Edmonton South Terminal, which has 15 major inbound pipelines and four major outbound pipeline connections; (2) North 40 Terminal, which has a highly diverse suite of ten inbound pipeline connection with access to variety of crude types and five outbound connections; (3) Base Line Terminal, which is a 50/50 joint venture between KML and Keyera Corp. (rated BBB with a Stable trend by DBRS) and is a 12-tank, 4.8 million-barrel facility, fully contracted to creditworthy customers; (4) Edmonton Rail Terminal, which has a capacity of approximately 210,000 b/d and is the largest origination crude oil by rail loading facility in North America; and (5) Alberta Crude Oil Terminal, which is served by the CN and CP railway network and is connected via pipeline to the North 40 Terminal and the Base Line Terminal. (Please see DBRS’s report on Kinder Morgan Canada Limited and Kinder Morgan Cochin ULC, dated March 25, 2019, for details).

(3) Vancouver Wharves Terminal (VWT): VWT is a 125-acre bulk marine terminal facility that transfers over four million tonnes of bulk cargo annually and is supported by fee-for-service-based contracts with creditworthy counter parties. The VWT has 1.0 million tonnes of bulk storage capacity, 250,000 barrels of petroleum storage capacity and facilities that can house up to 325 rail cars. (Please see DBRS’s report on Kinder Morgan Canada Limited and Kinder Morgan Cochin ULC, dated March 25, 2019, for details).

Financing Plan

Pursuant to the agreements, as mentioned above, the $2.3 billion Corporate Acquisition is expected to be an all-stock exchange, whereas the $2.05 billion Cochin Acquisition will be financed with an existing credit facility ($2.5 billion was available as at June 30, 2019) and a new $1.0 billion committed term loan facility with TD Bank. Subsequently, Pembina expects to refinance the acquisition with medium-term notes.

Assessing the Impact

Impact on Pembina’s business risk profile: DBRS views the proposed Transaction as having a modestly positive impact on Pembina’s business risk profile, reflecting the following factors: (1) Size and diversification are expected to improve modestly since Acquired Assets such as crude oil terminals and the condensate pipeline will expand Pembina’s asset diversification, as well as geographical diversification, further extending Pembina’s reach into the U.S. markets. With respect to the size, standing alone, Pembina’s EBITDA for the last 12 months ended June 30, 2019 (LTM 2019), was approximately $2.6 billion and is estimated to increase to nearly $3.0 billion in 2020. DBRS estimates that the Acquired Assets would provide approximately 10% of combined EBITDA following closing. (2) Strength and stability of cash flow are expected to improve with the current contracts at the Cochin Pipeline and storage assets. Most of these contracts are take-or-pay with no direct exposure to commodity price risk. Following the Transaction, Pembina’s exposure to commodity price risk is expected to decrease modestly. (3) Pembina’s value chain is expected to broaden through a strong strategic alignment of the Acquired Assets with Pembina’s conventional pipelines and oil sand pipelines. The Cochin Pipeline (reversed in 2014) is only one of two pipeline systems that transport condensate from the United States to meet the demand of the heavy oil producers in Western Canada.

Impact on the financial profile: Based on the current proposed financing plan, DBRS expects a modestly negative impact on Pembina’s credit metrics because of the issuance of incremental debt of approximately $2.05 billion for the Transaction. Although Pembina’s credit metrics are expected to weaken, the impact is modest and would not affect the current ratings. Pembina’s financial profile remained strong in 2018 and during the LTM 2019 with solid liquidity and strong credit metrics. For the LTM 2019, the cash flow-to-debt ratio was approximately 26%, EBIT interest coverage was approximately 6.65 times, and debt-to-capital (adjusted for the debt treatment of preferred shares) was under 40%. DBRS has done a pro forma assessment on the impact of the $2.05 billion acquisition debt on the three above-mentioned metrics and is satisfied that these metrics would still solidly support the BBB ratings.

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

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