With companies in all sectors tightening their waist line in the currently tough economic times, the outlook for the North American diversified natural gas transmission companies is stable, according to Mihoko Manabe, Moody’s vice president and senior credit officer. She noted that these companies are generally pulling back to focus on their regulated, low-risk businesses, working to reduce debt and enhance liquidity, and simplifying their business models.

In a new Moody’s Investors Service Industry Outlook, Manabe said that while no companies are currently on review for downgrades, approximately a third carry negative outlooks, due to the risk of not being able to carry through on further debt reduction and cash flow improvement plans.

“The industry’s current focus on ‘back to basics’ is supportive of improving credit quality,'” she said. “However, this sector could revert to riskier strategies that could again pressure ratings, as distressed companies regain their financial footing and investors begin expecting more earnings growth.”

The outlook found that 2003 has seen ratings stabilize after the industry’s average rating dropped during 2002 from A3 to low investment grade Baa2, and two companies lost their investment grade ratings. Three of the 13 companies in Moody’s peer group are currently rated non-investment grade. All of the companies in the group own interstate gas pipelines that they use as a platform for diversification into other businesses. In all, the companies have approximately $80.1 billion in rated debt outstanding. The 13 companies in Moody’s North American diversified gas transmission universe include Equitable Resources, MDU Resources, TransCanada Pipelines, Questar Corp., Consolidated Natural Gas, National Fuel Gas, NiSource, Duke Capital, Kinder Morgan Inc., Southern Union, CenterPoint Energy Resources, The Williams Companies and El Paso Corp.

Manabe noted that companies have been reacting to investor concerns over what had been relatively poor risk-adjusted returns and liberal accounting practices. During 2003, the study found that companies have avoided the inter-company transactions such as asset spin-offs and “drop-downs” that raised questions, while what had been the “burgeoning practice of creating master limited partnerships, or MLPs, has ended.”

She added that most companies have also improved their liquidity during the year, thanks to receptive bank and capital markets. Non-investment grade companies, however, remain particularly vulnerable “to the ebbs and flows of the high-yield capital market if they fail to become adequately self-financing” said Manabe. Looking ahead, she perceives a degree of risk emanating from new, outside investors being drawn into the industry, noting that new owners could change the financial performance of a pipeline, which offers stable revenues but little growth outside a periodic expansion or rate increase.

Manabe also noted that many companies, while curtailing their non-regulated activities, have been intensifying their exploration and production businesses. She said this could pose a challenge to a company looking to be self-funding, because E&P requires substantial reinvestment to offset depletion. She also emphasized that E&P increases volatility in cash flow and lowers a company’s capacity to service debt.

Moody’s said it continues to be concerned about the credit implications of remaining energy marketing and trading segments held by these companies. Despite the fact that many have been deemed non-core and offered for sale, their divestment has been slow going in the current market, the credit rating agency said.

“Over the next few years, we may well see M&A activity pick up as the battered merchant energy companies rebuild their creditworthiness and as financial investors approach the end of their investment horizon,” Manabe said. “M&A activity could also be fueled as investors demand more earnings growth than can be achieved through the pipelines’ regulated tariffs. Earnings growth-driven strategies could increase risk taking that could erode these companies’ credit quality.”

©Copyright 2003 Intelligence Press Inc. Allrights reserved. The preceding news report may not be republishedor redistributed, in whole or in part, in any form, without priorwritten consent of Intelligence Press, Inc.