PrefBlog

Moody’s Investors Service has announced:

Moody’s changed the rating outlook on ENB to positive from stable and changed the rating outlook on EIF to positive from negative.
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The positive outlook at ENB reflects the improvement in its financial profile that is the result of several factors. First, EBITDA continues to grow as the company executes its large capital program. The company expects to bring into service about CAD22 billion of projects by 2020, of which by FYE 2018 about CAD7 billion will be generating cash flow. Second, assets sales totaling CAD7.5 billion, of which CAD5.7 billion have closed, is well above the target of CAD$3 billion announced late last year. The proceeds from these sales, combined with equity and equity-like issuance helped the company reduce its debt by about CAD$3 billion in the year to date as it progresses its large capital program. Prospectively, Moody’s sees the size of the capital program declining, both in nominal terms and relative to the size of the company, which reduces pressure on forecasted financial metrics.

Enbridge Inc’s (ENB) Baa3 ratings reflect the company’s large size and scale and its diverse, low risk asset base offset by high, but improving leverage and structural subordination. The company’s portfolio of assets will continue to generate stable cash flow based on a combination of rate regulation, a favorable contractual profile and a strong competitive position.
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EIF has seen its ratio of debt to EBITDA improve substantially to 4.4x over the last twelve months ending Sept 30 2018 from 6.1x at FYE2017 a key driver of the change in outlook to positive from negative. The improvement is a result of strong operating performance, completed projects generating cash flow, increasing tolls and corporate actions that have led to reduction in debt even as the company progresses its CAD$5.3 billion share of the twice delayed CAD$9 billion Line 3 Replacement (L3R) project.
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ENB What Could Change the Rating — Up

• Moody’s adjusted debt to EBITDA is sustained comfortably below 5.5x.

• A large reduction in its organizational complexity and structural subordination

ENB What Could Change the Rating — Down

• Moody’s adjusted debt to EBITDA is sustained well above 6x.

• Increases in structural subordination, more aggressive financial policies or a material change in the company’s business risk could also lead to a downgrade.

ENB is rated Pfd-3(high) [Stable] by DBRS and P-2(low) [Stable] by S&P.

Affected issues are (deep breath): ENB.PF.A, ENB.PF.C, ENB.PF.E, ENB.PF.G, ENB.PF.I, ENB.PF.K, ENB.PR.A, ENB.PR.B, ENB.PR.C, ENB.PR.D, ENB.PR.F, ENB.PR.H, ENB.PR.J, ENB.PR.N, ENB.PR.P, ENB.PR.T and ENB.PR.Y.

Standard & Poor’s has announced (on October 1):

• •We are placing our ratings on Husky Energy Inc. on CreditWatch with negative implications, following its announced unsolicited bid to acquire oil sands bitumen producer, MEG Energy Corp.
• •We are also placing our ‘BBB-‘ global scale and ‘P-2(Low)’ Canada scale preferred share ratings on CreditWatch with negative implications, as we would lower them to ‘BB+’ and ‘P-3(High)’, respectively, concurrent with a downgrade on the company to ‘BBB’.
• •We are assuming Husky’s major shareholder will retain its majority ownership in the company, so we expect the one-notch uplift to its rating, which is supported by this ownership, should remain in effect.
• •The negative CreditWatch reflects the potential deterioration of Husky’s cash flow and leverage metrics, with the addition of MEG’s existing C$3.6 billion of debt (at June 30, 2018), and the resulting deterioration of the company’s financial risk profile, which could lead to a downgrade.

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S&P Global Ratings today placed its ratings on Calgary, Alta.-based Husky Energy Inc. on CreditWatch with negative implications, following the company’s announced offer to acquire MEG Energy Corp. The estimated value of the acquisition is C$6.4 billion, which includes the assumption of MEG’s debt of C$3.6 billion, and MEG’s June 30, 2018 cash balance of C$564 million. Husky intends to issue shares from its treasury and pay C$1 billion of cash in exchange for MEG’s equity outstanding.
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The negative CreditWatch reflects S&P Global Ratings’ opinion that Husky’s acquisition of MEG, with the assumption of about C$3.6 billion of debt, could weaken the company’s overall cash flow and leverage metrics below the minimum thresholds required to support the ‘BBB+’ rating. Without the company having a clearly articulated plan to delever its balance sheet immediately following the acquisition, Husky’s financial risk profile could weaken by one category, which would, in turn, cause us to lower the credit rating to ‘BBB’.

We expect to resolve the CreditWatch placement when the transaction closes. This should occur in early 2019.

DBRS commented (also on October 1):

Husky’s unsolicited offer has not been endorsed by MEG’s Board of Directors (Board). With the absence of Board support, Husky intends to commence an offer directly to MEG common shareholders by way of a takeover bid, which requires 66 2/3% of the total fully diluted shares tendered to Husky’s offer. DBRS notes the uncertainty in that Husky may not be successful with its proposal in the current form. DBRS also notes uncertainty as to (1) the time necessary to complete a successful offer and (2) the possibility that Husky may have to alter its offer to secure approval from MEG’s Board and/or common shareholders. Because of the uncertainties regarding the outcome of Husky’s offer, DBRS plans no rating action at the current time. However, should Husky be successful with its offer either in its current form or a modified form, DBRS may be compelled to take a rating action.

Nevertheless, DBRS notes that if Husky’s offer is successful in its current form, the addition of MEG’s assets would be mildly positive for Husky’s business risk profile. The inclusion of MEG’s assets (1) adds to Husky’s size, (2) improves the Company’s proven reserve life index, (3) complements Husky’s other thermal oil developments in Western Canada and (4) enhances Husky’s heavy oil integration plans. Tempering the improvement in the business risk profile is a higher level of asset concentration in Western Canada and a higher proportion of thermal oil in the Company’s production mix.

DBRS notes that Husky’s credit metrics (assuming Husky’s offer is successful in its current form) are modestly negatively affected initially due to the sizable amount of MEG debt that the Company would incur. On a pro forma basis (last 12 months ended June 30, 2018), Husky’s lease-adjusted debt-to-cash flow ratio rises from approximately 1.6 times (x) to 2.3x (outside the “A” range). However, Husky has noted that approximately $200 million in synergies could be realized annually from the acquisition of the MEG assets. Also, the combined entity is expected to generate material free cash flow (cash flow after capital spending and dividends) that can be deployed to reducing net debt and financial leverage. The Company anticipates a net debt-to-cash flow ratio of the combined entity (based on current strip pricing in 2019 for West Texas Intermediate oil of USD 70.50/bbl and a heavy light oil differential in Western Canada of USD 26.26/bbl) to be approximately 1.0x in 2019.

Affected issues are HSE.PR.A, HSE.PR.B, HSE.PR.C, HSE.PR.E AND HSE.PR.G.

Update, 2018-11-11: Moody’s considers the proposed acquisition credit negative:

If the transaction closes as structured it would be credit negative for Husky because of its leveraging nature and increased exposure to heavy oil differentials, but should be absorbed within Husky’s currently strong financial position and we would likely affirm Husky’s ratings.
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Husky would benefit from the addition of MEG’s high quality, long-lived reserves, a well understood reservoir with an established history of performance, future development opportunities, and a doubling Husky’s proved reserves. However, the assumption of MEG’s high Moody’s adjusted debt of about C$3.7 billion would be leveraging, reducing Husky’s expected 2019 retained cash flow to debt to about 35% from 45%. The addition of 2019 bitumen production would reduce Husky’s currently full integration of North American bitumen and heavy oil production, increasing its exposure to heavy oil differentials.

Husky (Baa2 stable) benefits from: 1) its integrated North American onshore upstream and downstream refining operations that provide diversity and lessen cash flow volatility; 2) the favorably priced contracts for its natural gas production offshore China; and 3) favorable cash flow-based leverage and interest coverage metrics. Husky is challenged by: 1) its exposure to volatile commodity prices in its North American heavy oil and natural gas segments and; 2) low margin upstream production, particularly at its Sunrise operation.

It will be recalled that PPL.PR.A will reset at 4.906% effective December 1.

PPL.PR.A is a FixedReset, 4.25%+247, that commenced trading 2013-7-26 after being announced 2013-7-17. It is tracked by HIMIPref™ and assigned to the “Scraps – FixedResets (Discount)” subindex, relegated there due to credit concerns.

The most logical way to analyze the question of whether or not to convert is through the theory of Preferred Pairs, for which a calculator is available. Briefly, a Strong Pair is defined as a pair of securities that can be interconverted in the future (e.g., PPL.PR.A and the FloatingReset that will exist if enough holders convert). Since they will be interconvertible on this future date, it may be assumed that they will be priced identically on this date (if they aren’t then holders will simply convert en masse to the higher-priced issue). And since they will be priced identically on a given date in the future, any current difference in price must be offset by expectations of an equal and opposite value of dividends to be received in the interim. And since the dividend rate on one element of the pair is both fixed and known, the implied average rate of the other, floating rate, instrument can be determined. Finally, we say, we may compare these average rates and take a view regarding the actual future course of that rate relative to the implied rate, which will provide us with guidance on which element of the pair is likely to outperform the other until the next interconversion date, at which time the process will be repeated.

We can show the break-even rates for each FixedReset / FloatingReset Strong Pair graphically by plotting the implied average 3-month bill rate against the next Exchange Date (which is the date to which the average will be calculated).

Click for Big

The market appears to be becoming interested in floating rate product; the implied rates until the next interconversion are above the current 3-month bill rate as the averages for investment-grade and junk issues are at +2.11% and +1.78%, respectively. Whatever might be the result of the next few Bank of Canada overnight rate decisions, I suggest that it is unlikely that the average rate over the next five years will be lower than current – but if you disagree, of course, you may interpret the data any way you like.

Since credit quality of each element of the pair is equal to the other element, it should not make any difference whether the pair examined is investment-grade or junk, although we might expect greater variation of implied rates between junk issues on grounds of lower liquidity, and this is just what we see.

If we plug in the current bid price of the PPL.PR.A FixedReset, we may construct the following table showing consistent prices for its soon-may-be-issued FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to be cheap and trading below the price of their FixedReset counterparts, PPL.PR.A. Therefore I recommend that holders of PPL.PR.A continue to hold the issue and not to convert. I will note that once the FloatingResets commence trading (if, in fact, they do) it may be a good trade to swap the FixedReset for the FloatingReset in the market once both elements of each pair are trading and you can – presumably, according to this analysis – do it with a reasonably good take-out in price, rather than doing it through the company on a 1:1 basis. But that, of course, will depend on the prices at that time and your forecast for the path of policy rates over the next five years. There are no guarantees – my recommendation is based on the assumption that current market conditions with respect to the pairs will continue until the FloatingResets commence trading and that the relative pricing of the two new pairs will reflect these conditions.

Those who wish to convert anyway are advised that the deadline for notifying the company of such a desire is < 3:00 p.m. (MST) / 5:00 p.m. (EST) on November 16, 2018. Brokers and other intermediaries generally set their internal deadlines a day or two in advance of this date, so if you wish to convert there’s not much time to waste! Note that brokers will, in general, try to execute the instruction on a ‘best efforts’ basis if received between the two deadlines, provided that the procrastinating shareholder grovels entertainingly enough.

It will be recalled that ENB.PR.N will reset at 5.086% effective December 1.

ENB.PR.N is a FixedReset, 4.00%+265, that commenced trading 2012-7-17 after being announced 2012-7-9. It is tracked by HIMIPref™ and assigned to the “Scraps – FixedResets (Discount)” subindex, relegated there due to credit concerns.

The most logical way to analyze the question of whether or not to convert is through the theory of Preferred Pairs, for which a calculator is available. Briefly, a Strong Pair is defined as a pair of securities that can be interconverted in the future (e.g., ENB.PR.N and the FloatingReset that will exist if enough holders convert). Since they will be interconvertible on this future date, it may be assumed that they will be priced identically on this date (if they aren’t then holders will simply convert en masse to the higher-priced issue). And since they will be priced identically on a given date in the future, any current difference in price must be offset by expectations of an equal and opposite value of dividends to be received in the interim. And since the dividend rate on one element of the pair is both fixed and known, the implied average rate of the other, floating rate, instrument can be determined. Finally, we say, we may compare these average rates and take a view regarding the actual future course of that rate relative to the implied rate, which will provide us with guidance on which element of the pair is likely to outperform the other until the next interconversion date, at which time the process will be repeated.

We can show the break-even rates for each FixedReset / FloatingReset Strong Pair graphically by plotting the implied average 3-month bill rate against the next Exchange Date (which is the date to which the average will be calculated).

Click for Big

The market appears to be becoming interested in floating rate product; the implied rates until the next interconversion are above the current 3-month bill rate as the averages for investment-grade and junk issues are at +2.11% and +1.78%, respectively. Whatever might be the result of the next few Bank of Canada overnight rate decisions, I suggest that it is unlikely that the average rate over the next five years will be lower than current – but if you disagree, of course, you may interpret the data any way you like.

Since credit quality of each element of the pair is equal to the other element, it should not make any difference whether the pair examined is investment-grade or junk, although we might expect greater variation of implied rates between junk issues on grounds of lower liquidity, and this is just what we see.

If we plug in the current bid price of the ENB.PR.N FixedReset, we may construct the following table showing consistent prices for its soon-may-be-issued FloatingReset counterpart given a variety of Implied Breakeven yields consistent with issues currently trading:

Based on current market conditions, I suggest that the FloatingResets that will result from conversion are likely to be cheap and trading below the price of their FixedReset counterparts, ENB.PR.N. Therefore I recommend that holders of ENB.PR.N continue to hold the issue and not to convert. I will note that once the FloatingResets commence trading (if, in fact, they do) it may be a good trade to swap the FixedReset for the FloatingReset in the market once both elements of each pair are trading and you can – presumably, according to this analysis – do it with a reasonably good take-out in price, rather than doing it through the company on a 1:1 basis. But that, of course, will depend on the prices at that time and your forecast for the path of policy rates over the next five years. There are no guarantees – my recommendation is based on the assumption that current market conditions with respect to the pairs will continue until the FloatingResets commence trading and that the relative pricing of the two new pairs will reflect these conditions.

Those who wish to convert anyway are advised that the deadline for notifying the company of such a desire is 5:00 p.m. (EST) on November 16, 2018. Brokers and other intermediaries generally set their internal deadlines a day or two in advance of this date, so if you wish to convert there’s not much time to waste! Note that brokers will, in general, try to execute the instruction on a ‘best efforts’ basis if received between the two deadlines, provided that the procrastinating shareholder grovels entertainingly enough.