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02 May 2003
MOODY'S DOWNGRADES THE DEBT RATING OF KANEB PIPE LINE OPERATING PARTNERSHIP, L.P. (TO Ba1 SENIOR UNSECURED)
Approximately $250 million of Debt Securities Affected
New York, May 02, 2003 -- Moody's Investors Service downgraded the senior unsecured debt rating
of Kaneb Pipe Line Operating Partnership, L.P. (KPOP)
to Ba1 from Baa3. The rating outlook is stable.
This rating action concludes a rating review that was prompted by concerns
raised by a rapid succession of four large and diverse acquisitions consummated
last year. KPOP's acquisition of the Northern Great Plains
Products System (North Pipeline) from Tesoro Petroleum Corporation for
$100 million in cash, which closed in December 2002,
closely followed those of Statia Terminals for $285 million in
February 2002, terminals in Australia and New Zealand for US$47
million in September, and an ammonia pipeline for $140 million
in November. Together, these acquisitions roughly doubled
KPOP's assets and debt from year-end 2001 levels.
The downgrade reflects concerns about:
1) the decline in KPOP's overall credit quality from the acquisitions
of businesses -- in particular Statia and the ammonia pipeline
-- that have shown variability and declining financial results
in recent years;
2) the company's yet-to-be established track record
in integrating and operating this diverse set of assets; and
3) the probability that KPOP will make other acquisitions in the future,
and its demonstrated willingness to step out from its existing geographic
and product scope.
The stable outlook takes into consideration the historic performance of
KPOP's new assets under prior ownership as well as tariff increases,
certain investments and other changes that KPOP expects under its ownership.
Except for Statia, which was a public company prior to its acquisition,
the other transactions were acquisitions of assets which, as integrated
parts of large organizations, never had standalone audited financial
records. It remains to be seen how these assets perform on a standalone
basis under new ownership. A rating action could result if these
assets' future performance varies significantly from the company's
estimates, and if KPOP again makes acquisitions of a size and character
that alter its credit profile.
Despite its rapid growth last year, with $1.2 billion
of total assets, KPOP is still smaller than the average company
in Moody's MLP peer group. Debt-to-gross cash
flow (debt, pro forma for the March equity offering, plus
operating leases-to-cash flow from operations before working
capital changes) was roughly 6 times for fiscal 2002. Moody's
notes that this ratio reflects the full value of acquisition debt compared
against a partial year's worth of cash flow from the acquired assets.
Nevertheless, debt protection measures have shown a weakening trend
over the past few years. While debt has risen to a higher permanent
level, KPOP's coverages (EBITDA-to-interest
adjusted for rent expense in the 4 times range) and returns (EBITDA adjusted
for rent-to-assets at 12%, after the above
acquisitions) have declined over the past few years.
KPOP has two broad segment lines: terminals (roughly 70%
of assets and EBITDA) and pipelines (the balance of assets and EBITDA).
Pipelines have historically been more profitable and therefore have had
higher returns than terminals, which themselves have enjoyed good
results. KPOP's long-owned product pipelines have
posted EBITDA-to-revenues well in the 50% range and
EBIT-to-assets in the 30% range. (These high
returns are due in part to the pipeline assets having been owned by Kaneb
entities for a long time and being booked at a low basis.) KPOP's
long-owned terminals' EBITDA-to-revenues have
fluctuated in the 40% range, its returns at around 10%.
KPOP's future credit quality could be pressured if the company is
not successful in integrating its new businesses and replicating the profitability
and returns that it has enjoyed with its longer held assets. The
company will be challenged by the incremental interest expense of the
acquisition debt and some identified upfront expenses (e.g.,
spending on the de-bottlenecking project for the ammonia pipeline,
and on the construction of a lateral to connect its new North Pipeline
with its existing East Pipeline). These along with unexpected costs,
should any arise, could cause the new assets to post weaker results
than KPOP's pre-existing assets and lower the company's
financial performance overall.
ANALYSIS OF THE RECENTLY ACQUIRED ASSETS
Statia. Statia's financial performance for the ten months
it was owned by KPOP was reduced by certain items related to change in
ownership and transition to new management (e.g.,
a payment to prior management that left the company at mid-year).
This business was also adversely affected by a fluctuating competitive
environment, contracts that were not renewed, and other factors.
Historically, Statia's cash flows have been more volatile
than those of KPOP's other terminals because of Statia's exposure
to the forward market for crude oil, refinery activity, and
hurricanes, any of which could again affect results in the future.
In addition, Statia is exposed to contract renewal risk, since
many of its storage and throughput contracts are short-term.
While this is not unusual in the terminaling business, Statia has
experienced more competitive pressure than have many of KPOP's other
terminals, and this could potentially lower capacity utilization
At $285 million enterprise value (about 8 times Statia's
normalized 2001 EBITDA), the acquisition was fully valued.
The largest acquisition in Kaneb's history, Statia comprises
a significant part of KPOP's credit profile, accounting for
roughly 30% of its consolidated assets and a lower proportion of
its expected earnings. Given KPOP's significant investment
in Statia, the incremental depreciation and interest expenses assumed
in this acquisition could weigh on KPOP's future overall financial
performance if it is not successful in generating the level of cash flow
that it expected from these assets.
Australia and New Zealand Terminals. This US$47 million
acquisition, the smallest of Kaneb's 2002 acquisitions,
closed last September. KPOP expects these terminals to make up
less than 5% of its pro forma consolidated revenues, EBITDA,
and assets. The business enjoys a high market share in most of
its locations and higher-margin service offerings, both of
which contribute to strong historic results that are akin to those of
KPOP's U.S. terminals. Moody's would
view with concern any further significant expansions into non-U.S.
Ammonia Pipeline. Kaneb acquired this pipeline for $140
million in cash just last November. Accounting for about 10%
of KPOP's total assets, the ammonia pipeline is of a size
that could have a significant impact on overall results. In each
of the past three years under prior ownership, this pipeline's
cash flows fell because of various factors including wetter-than-normal
weather, high natural gas prices, disruption in ammonia imports,
and a bankruptcy of a major shipper. Although the pipeline can
mitigate some of these risks by its unique ability to access cheaper imports
when high gas prices make domestic ammonia production less economic,
it is still exposed to weather and shipper concentration risks.
Furthermore, stricter government mandates for pipeline safety could
pressure future costs upward and compress margins. Higher tariffs
were just put in place in last month, which will help to increase
North Pipeline. This pipeline was acquired at year-end 2002
for $100 million in cash. This is the only acquisition that
KPOP made last year that has direct synergies with its pre-existing
assets. The North Pipeline lies perpendicular to the East Pipeline,
KPOP's primary pipeline asset, and a lateral currently being
built to connect the two could result in synergies that enhance the profitability
of the combined systems. The North Pipeline's revenues should
also benefit from a recent rate increase.
KPOP is the principal operating subsidiary of Kaneb Pipe Line Partners,
L.P. (the parent, KPP), a publicly traded master
limited partnership. Debt is issued at the KPOP level, and
equity units are issued by KPP.
KPOP has restored its leverage (debt-to-capital currently
at about 55%) to near pre-acquisition levels of 2001 after
four equity issuances since January 2002 that raised about half of the
$600 million it paid for acquisitions last year. The company's
leverage had risen to 64% at year-end 2002 from a bridge
loan for the North Pipeline acquisition that had closed only a week before,
and which has since been paid down with proceeds from an equity offering
Nevertheless, Kaneb's acquisition strategy may well lead to
future spikes in KPOP's debt levels, with the timing of subsequent
debt reductions dependent on the company's ability to raise equity.
As is common among master limited partnerships, KPP distributes
out to its unitholders the cash flow available after minimal maintenance
capital expenditures. This practice does not leave free cash flow
otherwise available for debt reduction. Thus, any meaningful
debt reduction will come from proceeds from equity issues. Moody's
notes that the master limited partnership market is less liquid than the
stock market, and being yield-oriented, may be vulnerable
to a rise in interest rates in the future.
Kaneb Pipe Line Operating Partnership, L.P. is a subsidiary
of Kaneb Pipe Line Partners, L.P. Headquartered in
Richardson, Texas, Kaneb Pipe Line Partners, L.P.
is a publicly traded master limited partnership.
Corporate Finance Group
Moody's Investors Service
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
No Related Data.
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