The Long and Short

A surprise upgrade for Energy Transfer

| August 18, 2023

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Energy Transfer LP (ET) recently announced a $7.1 billion all-stock acquisition of Crestwood Equity Partners LP (CEQP) and picked up an upgrade from S&P. The deal provides ET with complementary gathering and processing assets as well as storage and terminal assets. ET credit metrics should largely remain unchanged given the use of equity in the acquisition. The deal also should immediately add to distributable cash flow and provide for annual run-rate synergies. While all three rating agencies already had ET on positive outlook, S&P upgraded ET’s senior unsecured ratings by one notch after the announcement. The timing was a bit of a surprise, as the Street largely expected ratings to move up only after the close and after ET realized the synergies.

Given the improved ratings profile and credit metrics that are favorable to some mid-BBB peers, ET’s bonds are poised for upside and spreads should collapse closer, if not through, Kinder Morgan Inc. (KMI). ET currently trades roughly 15 to 40 bp behind KMI, with the largest trading differential between the two credits in the long end of the curve. The anticipated improvement to cash flow and expected annual run-rate synergies should strengthen leverage metrics further. There is negligible risk for ET’s curve to reprice wider, given that the deal is being funded with equity.

Exhibit 1. ET/KMI Spread Curves

Source: Bloomberg TRACE; Santander US Capital Markets

Overview of Merger

ET and CEQP have entered into a definitive merger agreement in which ET will acquire CEQP in an all-equity transaction, which is valued at $7.1 billion. The transaction valuation includes the assumption of $3.3 billion of CEQP debt. CEQP common holders will receive 2.07 ET units per every CEQP unit, which translates to roughly $2.7 billion of equity value (based on closing prices as of 8/15/23). Upon closing, CEQP common holders will own 6.5% of ET outstanding common shares. The deal is expected to close in the fourth quarter of 2023 and is subject to regulatory approvals.

ET anticipates the deal will be immediately accretive to distributable cash flow and noted that leverage metrics will remain in the low 4.0x area post close, despite the assumption of debt. Management has been targeting leverage in the 4.0x-4.5x area. Additionally, ET expects to achieve at least $40 million of annual run rate synergies at two years post close, with roughly 50% of that figure achieved in the first combined year.

Complementary Assets Underscore Link-Up

The acquisition of the CEQP helps to extend their position in the value chain of the Williston and Delaware basins, while providing for entry into the Powder River basin (Exhibit 2). CEQP’s system includes:  2.0 billion cubic feet of gas per day of gathering capacity; 1.4 billion cubic feet of gas per day of processing capacity; and 340 thousand barrels per day of crude gathering capacity across the basins. The assets complement ET’s downstream fractionation capacity at Mont Belvieu, while extending its hydrocarbon export capabilities from terminals located in Texas and Pennsylvania. Additionally, CEQP’s storage and terminal assets coupled with their trucking and rail terminals benefit ET’s NGL & Refined Products and Crude Oil businesses. The addition of CEQP adds approximately 10 million barrels of storage capacity.

Exhibit 2. Combined Asset Footprint

Source: CEQP Presentation; Santander US Capital Markets

When looking at ET’s cash flow breakdown, the addition of CEQP adds to ET’s two largest cash flow generating units. Additionally, approximately 85% of CEQP’s EBITDA is fee based, which is similar to ET’s percentage. Additionally, CEQP’s contracts are long-term in nature, with an average remaining life of 9+ years. These contracts are predominately with IG counterparties, providing for cash flow stability. The complementary asset footprints in the Williston and Delaware basins also provide for substantial synergy realization on both the operational and cost sides. ET has noted that CEQP’s annual cost base accounts to roughly $300 million, which is set to decline materially once integrated with ET. ET’s higher ratings also provide for the potential to refinance or repay higher coupon debt at CEQP which is being assumed in the transaction.

ET Stacks Up Favorably to KMI

Despite having lower ratings at two rating agencies, ET’s credit profile stacks up very favorably to KMI. Currently, ET’s leverage is two ticks lower than KMI’s and has the potential to fall further upon consummation of the deal as synergies are realized. With an increased cash flow profile, ET could look to further strengthen its balance sheet and repay debt. Given that this is ET’s second acquisition in 2023, management may focus on debt reduction post close. ET repaid over $3.0 billion of debt in 2021-2022 after the assumption of debt in prior acquisitions. Additionally, coverage is over a turn higher than KMI. While coverage may decline slightly post close given the higher coupons associated with CEQP’s debt, ET could look to target those bonds for repayment and/or refinancing. KMI currently maintains a higher leverage target than ET, which leaves KMI with some headroom to operate with higher leverage under its current financial policies.

Exhibit 3. ET vs. KMI Credit Profile Comparison

Source: Company Reports; Bloomberg; Santander US Capital Markets

S&P Upgrades While Moody’s Affirms

S&P was quick to upgrade ET to BBB with a stable outlook subsequent to the acquisition announcement. Additionally, ET’s CP rating was raised one notch to A-2. S&P highlighted management’s use of equity to fund the transaction, noting the company’s ability to maintain leverage in the low 4.0x area while maintaining its robust balance sheet. The agency views the transaction as being supportive of its public stated financial policy which reflects management’s financial prudence. Should the deal not be consummated, S&P noted that it will have no impact on the new ratings as the upgrade reflects ET’s financial discipline surrounding its leverage target. Leverage has been maintained at the low end of management’s 4.0x-4.5x target range and is expected to do so moving forward.

Moody’s took a slightly different approach and affirmed ET’s BBB- rating and positive outlook. The agency believes the acquisition will strengthen ET’s position in the Williston and Delaware basins, and the complementary assets will help ET to realize considerable synergies upon integration. The increased cash flow expected to be generated post close should provide for accelerated debt reduction according to the agency. Moody’s provided no timing on a potential upgrade or resolution of the positive outlook.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

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