Which MLPs Have an Investment Grade Rating?

Over the past 10 days, there have been two big acquisition announcements in the master limited partnership space. In both cases, the CEO of the acquiring partnership stressed that the primary motivation for the acquisition was the hope that the new assets would trigger a credit rating upgrade from ratings agencies like Standard & Poor's.

These ratings are a big deal because they have a direct impact on an MLP's cost of capital. With that in mind, today we're looking at which MLPs already have an investment grade rating and what other MLPs need to do to join their ranks.

Label me
First and foremost, Standard & Poor's does not rate every single master limited partnership. Of the 100 or so MLPs that exist today, approximately 56 carry ratings from S&P. Of that group, only 16 are rated investment grade. Remember, S&P defines investment grade as anything rated BBB- or higher.

Here are the 16 MLPs that make the grade:

Source: S&P.

Though the S&P rating system goes as high as AAA, no master limited partnership has attained that rating. The business structure of an MLP is inherently more risky than a corporation, which will most likely prevent any from ever attaining the highest rating. In fact, Enterprise Products Partners became the first MLP to reach the BBB+ level just this past February. Magellan Midstream Partners followed shortly thereafter, receiving the same rating in July.

As the above chart suggests, there are a handful of MLPs in line hoping to be the next to qualify for the BBB+ rating. Some will have a much better chance than others, however, despite having the same BBB today. For example, S&P slapped Enbridge Energy Partners with a negative outlook last November, and reaffirmed that negativity this past May. You can get a sense of the agency's logic with this excerpt from its press release:

The negative outlook reflects rating pressure from the partnership's elevated financial measures and tight covenant cushion as it pursues major capital expansions with delayed cash flows, and ongoing expenses associated with its oil spill cleanup.

Enbridge Energy Partners is a bit of a mess right now, and Kinder Morgan Energy Partners or Boardwalk Pipeline Partners are likely better candidates for an upgrade. But why? What exactly drives these ratings?

The system
Standard & Poor's methodology for rating midstream companies is a long and winding road (which you can read about in its entirety here), but there are a few boxes that every MLP must check if it's looking to attain an investment grade rating:

• Debt: 4.5 times debt to EBITDA is the limit; ideally, it's 4.0 times or lower.
• Distribution coverage ratio: Keep it above 1.0 times coverage.
• Revenue: As stable as possible, fee-based revenues are a big winner here, exposure to commodity prices is not.
• Business Mix: Diversity is king, and that goes for geographical footprint as well as asset make-up. One-trick ponies need not apply.

When you look at this list, you can begin to gauge why an Enbridge Energy Partners may have a negative outlook and why Energy Transfer Partners might see an upgrade coming its way sometime next year. The partnership is much more diverse, both from an operational and geographical standpoint, than it was three years ago. On top of that, it finally (finally!) has its act together financially and is increasing its distribution. Investors can track the above metrics and have a sense of when the ratings tide might turn for Energy Transfer.

Bottom line
It's fair to be skeptical of ratings agencies, given their role in the financial crisis, and by no means should investors confuse a solid rating for a signal to buy. That said, the key factors to a great rating also signify a great business. Additionally, these ratings really do matter because they affect an MLP's cost of capital, and therefore they shouldn't be dismissed entirely.