Midstream credit ratings are a recurring topic in Alerian Insights (2017, 2016, 2015 3-part series) - not because we're too lazy to think of new topics (OK, that may be a small part of the reason), but because credit ratings are important for midstream companies as prolific project builders. Often, midstream projects are financed with 50% debt. A better credit rating means cheaper debt and better project returns, hence the desirability of investment-grade credit ratings for midstream companies.
In this piece, we'll look at credit ratings for the 59 constituents of the Alerian Midstream Energy Index (AMNA), a broad-based composite of North American energy infrastructure companies. We'll also look at the investment-grade weightings for five of our midstream indices. Before we get into those details, we'll briefly revisit why credit ratings matter.
What is the value of an investment-grade rating?
For midstream companies, an investment-grade credit rating is not just a feather in the cap or a perceived stamp of approval from a rating agency. Rather, an investment-grade credit rating means saving cash. For example, Andeavor Logistics (ANDX) anticipated more than $25 million in savings for annual interest costs as a result of refinancing its debt in late 2017 after achieving an investment-grade rating. Tallgrass Energy (TGE) and Rockies Express Pipeline LLC received investment-grade credit ratings from Fitch in September, and TGE noted in its October presentation that a potential improvement to its credit rating would reduce its cost of debt. TGE also stated in the presentation that S&P had recently revised its outlook to positive watch. For midstream companies, preserving or attaining an investment-grade credit rating is clearly important.
Making the grade: midstream credit ratings and takeaways.
The table below includes S&P credit ratings for the midstream companies included in the AMNA index as well as yield and market capitalization. We focus on S&P ratings because those are used to determine the investment-grade weightings1 for our indices.
Of the 59 constituents in the AMNA index, 41 names have ratings from S&P. Of those 41 names with ratings, 22 companies have investment-grade ratings (BBB- or better). In other words, of the companies with ratings, more names have investment-grade ratings than below investment-grade ratings. The average market cap for investment-grade rated names is ~$23 billion, but the range is quite wide: from Enbridge (ENB) at $98 billion to TC PipeLines (TCP) with a market cap below $2.3 billion. One would expect investment-grade companies to have lower yields (cheaper equity). The average yield for investment-grade names was 7.1% as of February 28, compared to an average yield of 9.9% for those names with ratings below investment grade and paying a dividend. There is a wide range of yields and market caps among the names without S&P ratings, which include TGE despite its investment-grade rating from Fitch and Plains GP Holdings (PAGP), although Plains All American (PAA) has an investment-grade rating.
What is the investment-grade weighting in Alerian indices?
The chart below shows the weighting of constituents with investment-grade credit ratings from S&P in five of our midstream indices. Given midstream equity yields shown in orange below, investors may expect lower credit quality for the sector than is the case. One factor in the heavy weighting of investment-grade companies for midstream is the barbell nature of market capitalizations in this space. The indices below are weighted by float-adjusted market capitalization with a 10% cap. As an example, seven companies of the 59 constituents in the AMNA Index account for almost three-fourths of the investment-grade weighting for the index.
As shown in the chart below, AMNA, our composite midstream index, has the highest weighting of investment-grade companies at 83.3%, followed by the Alerian MLP Infrastructure Index (AMZI), which includes energy infrastructure MLPs. The Alerian US Midstream Energy Index (AMUS) is similar to AMNA but only includes US energy infrastructure companies. Finally, the Alerian Midstream Energy Select Index (AMEI) is the investable version of the AMNA Index. AMEI caps MLPs at 25% and includes a liquidity requirement. The Alerian MLP Index (AMZ) has the lowest investment-grade weighting at 70.4%. The AMZ consists of energy infrastructure MLPs but is broader than the AMZI (the AMZ has twelve more constituents). One may expect that the index with the highest investment-grade weighting (AMNA) has the lowest yield, and the index with the lowest investment-grade weighting (AMZ) has the highest yield. For a helpful infographic distinguishing these five indices, please see the appendix to this piece.
Investment-grade credit ratings are important to midstream companies as a means to lower borrowing costs - which, in turn, supports better project returns. Midstream's reliance on debt markets for financing growth projects and the barbell nature of market capitalizations result in a heavy weighting to investment-grade companies across our midstream indices.
1 To be clear, an investment-grade rating is not a criteria for inclusion in our indices, but we report investment-grade weightings for our indices in fact sheets, as it is a metric frequently requested by investors.
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Stacey Morris is the Director of Research at Alerian, which equips investors to make informed decisions about Master Limited Partnerships (MLPs) and energy infrastructure. Ms. Morris engages with the investment community to increase awareness of the Alerian Index Series and support broader understanding of the role that midstream assets play in North American energy markets. Ms. Morris was previously the Investor Relations Manager for Alon USA Energy, overseeing investor communications for the corporation and its variable distribution MLP, Alon USA Partners. Prior to Alon, she covered the integrated majors and refiners at Raymond James as a Senior Associate in the firm's Equity Research Division. Ms. Morris graduated summa cum laude with a Bachelor of Science in Business Administration from Stetson University, and is a CFA charterholder.