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In midstream sector, Q1 results reflected changes made to survive

For large midstream energy companies, the first quarter of 2017 represented a step back toward the steady growth the sector had grown accustomed to before a commodity price downturn forced companies into survival mode last year.

Most of the largest oil and natural gas transporters in North America reported solid growth in adjusted EBITDA and distributable cash flow, two key metrics used by the midstream finance community to look at the cash those companies are generating and what they're able to pay to their shareholders. Combined with the distribution cuts many companies made over the past 18 months, the results show midstream companies back on more solid ground.

CreditSights analyst Charles Johnson noted that first-quarter results emphasized security over growth. "You've heard a number of management teams say things like, 'We need to get to this certain leverage point before we start worrying about that again … we need to get back to a little healthier coverage before getting back to distribution growth,'" he told S&P Global Market Intelligence.

In terms of adjusted EBITDA growth, eight of 10 companies reported growth. Plains All American Pipeline LP stood as an outlier, reporting worse than expected financials that the partnership blamed on an under-performing natural gas liquids segment.

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Distributable cash flow, which typically backs out expenses such as maintenance CapEx from adjusted EBITDA, also showed growth for the majority of companies. Magellan Midstream Partners LP increased its distributable cash flow by $22.3 million since the year-ago period to top its peers in that category.

Those gains in distributable cash flow translate into encouraging coverage ratios when divided by the total amount of distributions paid, signaling just how far midstream companies have come since oil prices tanked in 2014.

"Until we saw energy prices really fall off in the second half of 2014, we'd had multiple years of investors being very used and companies being very used to sort of standing on the gas pedal and pushing distribution growth as kind of the primary metric," MUFG Securities Americas Inc. analyst Barrett Blaschke said during a May 16 conference call with members of the press.

During the downturn, he added, companies began to focus instead on stability through improving distribution coverage and balance sheet deleveraging. "I think the general attitude today is, 'Yes, I'm happy [you're] growing distribution at 7% or 8% instead of 10% as long as that means you're just reaching coverage of 1.2x or 120% versus being just under or right at 1x where you've got just less margin for error.'"

Reaching those improved coverage ratios and more solid financial results was not easy. Most of the top companies overhauled major parts of their operations. Enbridge Inc. purchased Spectra Energy Corp, Kinder Morgan Inc. slashed its dividends, Williams Cos. Inc. cut dividends then repositioned its hold on Williams Partners LP. Plains and ONEOK Inc. engaged in simplification transaction and Energy Transfer Partners LP combined with Energy Transfer peer Sunoco Logistics.

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Crude oil prices remained low throughout the first quarter of 2017, but Tortoise Capital Advisors LLC Managing Director Rob Thummel said that while higher prices would have produced better earnings in general, dividend growth and distribution growth still met predictions.

"You're on a pace to get 6%, 7% dividend growth from these companies, which frankly we think is pretty strong," he said in an interview.

While midstream companies demonstrated improved financial footing, the sector as a whole is still in the process of recovering from two-years-plus of subdued commodity prices.

"I don't know that anyone was expecting a huge first quarter on the midstream side of things," Fitch Ratings senior director Peter Molica told S&P Global. "We're kind of in a transition period."