New York, Sept. 29, 2003 — The outlook for the North American diversified gas transmission companies is stable, as they generally pull back to focus on their regulated, low-risk businesses, work to reduce debt and enhance liquidity, and simplify their business models, says Moody’s Investors Service in a new Industry Outlook.
“The industry’s current focus on ‘back to basics’ is supportive of improving credit quality,'” says Moody’s Vice President/Senior Credit Officer Mihoko Manabe, author of the Outlook. “However, this sector could revert to riskier strategies that could again pressure ratings as distressed companies regain their financial footing and investors begin expecting more earnings growth.”
While no companies are currently on review for downgrades, approximately a third carry negative outlooks, Manabe notes, due to the risk of not being able to carry through on further debt reduction and cash flow improvement plans.
She says 2003 has seen ratings stabilize after the industry’s average rating dropped during 2002 from A3 to low investment grade Baa2, and two companies lost their investment grade ratings. Three of the 13 companies in Moody’s peer group are currently rated non-investment grade. Moody’s diversified gas transmission companies all own interstate gas pipelines that they use as a platform for diversification into other businesses. In all, the companies have approximately $80.1 billion in rated debt outstanding.
Manabe says companies have been reacting to investor concerns over what had been relatively poor risk-adjusted returns and liberal accounting practices. During 2003, companies have avoided the inter-company transactions such as asset spin-offs and “drop-downs” that raised questions, while what had been the burgeoning practice of creating master limited partnerships, or MLPs, has ended.
Most companies have also improved their liquidity during the year, thanks to receptive bank and capital markets, she says. Non-investment grade companies, however, remain particularly vulnerable “to the ebbs and flows of the high-yield capital market if they fail to become adequately self-financing” says Manabe.
She perceives a degree of risk emanating from new, outside investors being drawn into the industry. New owners could change the financial performance of a pipeline, which offers stable revenues but little growth outside a periodic expansion or rate increase.
While companies have curtailed their non-regulated activities, many have been intensifying their activities in exploration and production (E&P). Manabe says this could pose a challenge to a company looking to be self-funding, because E&P requires substantial reinvestment to offset depletion. She says emphasizing E&P increases volatility in cash flow and lowers a company’s capacity to service debt.
Moody’s also continues to be concerned about the credit implications of remaining merchant energy-related activities such as energy marketing and trading and power. While many have been deemed non-core and offered for sale, their divestment has been difficult in a depressed market. The business risk and cash flow volatility they create therefore remains.