Fitch affirms Delek Logistics partners

Fitch Ratings has affirmed Delek Logistics Partners, L.P. (DKL) Long-Term Issuer Default Rating (IDR) at 'BB-'. The senior unsecured notes co-issued by Delek Logistics Partners, L.P. and Delek Logistics Finance Corp. have also been affirmed at 'BB-'/'RR4'. The Rating Outlook is Stable.

The affirmation of DKL's IDR considers its rating linkage with Delek US Holdings (Delek Holdings; BB-/Stable) and the resulting rating uplift from Delek Holding's stronger standalone credit profile (SCP) under Fitch's Parent and Subsidiary Linkage Criteria. DKL's SCP is consistent with a 'B+' rating due to its sustained high leverage ratio.

DKL's rating is supported by its location-advantaged assets, growing size and scale, and ongoing initiatives in diversifying its customer base and service offerings. This is balanced by the partnership's high distribution, elevated capital needs and business risk associated with the acquired assets.

Key Rating Drivers

Leverage Elevated by Aggressive Growth: Fitch considers leverage to be a crucial aspect of DKL's credit profile due to the partnership's counterparty and geographic concentration, as well as the significant distributions inherent in the MLP model. Fitch projects that leverage will rise to approximately 4.8x by 2024 and remain above 4.0x in the following years, primarily driven by growth initiatives and the major contract renewal with Delek Holdings announced on the 2Q24 earnings call.

Fitch does not anticipate a significant reduction in leverage in the near term through internally generated FCF. The partnership's post-dividend FCF has been negative for the past two years, and Fitch expects this trend to continue due to high capital requirements and a steady increase in shareholder distributions. Fitch also assumes there will be some execution risk in integrating the newly acquired assets.

Parent Support Enhances Rating: DKL's ratings reflect one-notch uplift due to the rating linkage with its parent, Delek Holdings. Delek Holdings' SCP is stronger given the adequate liquidity and moderate leverage. The linkage between the companies follows a strong parent/weak subsidiary approach. Legal incentive is weak given the lack of guarantees.

Strategic incentives are also weak as Delek Holdings is actively pursuing the divestiture of DKL. Operational incentives are assessed as medium, given integrated assets and shared management of the two companies. This results in DKL's ratings receiving a one-notch uplift.

Growth Supported by Strategic Location: DKL benefits from its strategic location in the Permian Basin, where oil production has remained resilient through various commodity price cycles. The acquisitions of the Delaware Gathering System and H2O Midstream assets have expanded DKL's asset base in the Permian, providing the company with increased scale, a diversified customer base and an expanded service offering.

The construction of an additional natural gas processing plant positions DKL for continued growth even in a softening commodity price environment. However, Fitch notes that midstream service providers with a single-basin focus are exposed to significant risks if there are any substantial disruptions or slowdowns in the region's refining markets or hydrocarbon production.

Counterparty Exposure: Despite the acquisition of the Delaware Gathering System in 2022, Delek Holdings remains the largest counterparty for DKL, accounting for approximately 58% of DKL's net revenue and approximately 50% of EBITDA as of Q2 2024.

Fitch anticipates that this cash flow concentration will persist in the near term until the recently announced growth initiatives and contract amendments take effect and diversify DKL's customer base. While DKL's customer concentration risk is likely to decrease due to higher third-party EBITDA, the partnership maintains significant exposure to non-investment grade (non-IG) and/or unrated counterparties.

Volumetric Risk and Direct Commodity Price Exposure: The partnership's revenue is supported by long-term fixed-fee contracts with minimum volume commitments (MVCs) from Delek Holdings and some other customers. Increasing third-party EBITDA contribution may potentially expose the partnership to higher volumetric risk. According to Fitch's observation, gathering and processing contracts in the Permian Basin typically lack volume assurance terms.

DKL has modest exposure to volatility in commodity and refined product prices when it takes ownership of these products. Direct commodity price exposure historically accounted for about 5% of EBITDA, primarily within the West Texas wholesale marketing segment, and is largely hedged. Fitch anticipates that commodity price exposure will slightly increase with the sale of skim oil from the wastewater disposal business.

Delek Logistics Partners, LP has an ESG Relevance Score of '4' for Group Structure due to material related party transactions with its sponsor Delek Holdings, which has a negative impact on the credit profile, and is relevant to the rating[s] in conjunction with other factors.

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

Derivation Summary

DKL's ratings are supported by the ratings of its parent Delek Holdings. In the absence of an explicit rating linkage between DKL and Delek Holdings, Fitch views DKL's standalone credit profile as consistent with 'B+' rated midstream issuers.

Considering DKL's increasing scale in gathering and processing (approximately 50% of EBITDA) and its location in the Permian Basin, Medallion Midland Acquisition, LP (Medallion; B+/Stable) can be seen as a close peer to DKL. Medallion is a high-growth midstream services company with assets primarily in the Midland Basin. The company provides crude oil gathering and intrastate transportation services (approximately 85%) in Texas and is expanding its marketing businesses (approximately 15%). Unlike DKL, Medallion is predominantly involved in the gathering and processing business with a fully built out network in the region.

With slightly over $200 million in annual EBITDA, Medallion is smaller in size and only a small percentage of its revenue is supported by MVCs. Medallion has a lower counterparty concentration risk and relies solely on organic growth to steadily increase its scale. Its leverage is slightly above 4.0x, and Fitch expects it to fluctuate between 4.0x and 4.5x during the forecast period. Both companies have similar standalone credit profile due to Medallion's modestly higher business risk being balanced by its lower leverage ratio.

Harvest Midstream I, L.P. (HMI; BB-/Stable) is another comparable company. HMI is similar in size to DKL, with revenue concentrated in a high-yield counterparty and a growth strategy focused on acquisitions. The company provides midstream services for both oil and natural gas and operates across five distinct basins, which Fitch views as credit supportive. HMI aims for a leverage target of 3.0x to 3.5x.

While its current leverage is slightly above 3.5x due to recent acquisitions, Fitch expects this ratio to decline to 3.5x by 2025. The combination of HMI's modestly lower business risk and lower leverage results in a one-notch difference compared to DKL's standalone rating.

Key Assumptions

--Fitch price deck for WTI oil price of $75/bbl in 2024, $65/bbl in 2025, $60/bbl in 2026 and 2027, and $57/bbl thereafter;

--Fitch price deck for Henry Hub prices of $2.5/mcf in 2024, $3.0/mcf in 2025 and 2026, and $2.75/mcf thereafter;

--Fitch Global Economic Outlook interest rate assumptions;

--One refinery turnaround each year;

--Capex and distributions for 2024 largely in line with management guidance;

--No significant acquisition, asset sales or drop down from Delek Holdings assumed beyond what was announced in August 2024;

--No additional contract amendment with DK.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:

An upgrade is unlikely in the near term. However, Fitch may consider positive rating action if:

-- Demonstrated ability to maintain the EBITDA leverage at or below 4.0x and distribution coverage above 1.0x on a sustained basis, together with a favorable rating action at Delek US Holdings.

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:

-- Expected leverage above 5.0x and/or Distribution Coverage below 1.0x on a sustained basis;

-- A material change in contractual arrangements or operating practices, or a significant deterioration in customer quality with Delek Holdings, which negatively affect DKL's cash flow and earnings profile, as long as Delek Holdings remains a significant counterparty;

-- Unfavorable rating action at Delek Holdings or change of Delek Holdings' ownership interest in DKL;

-- Impairments to liquidity.

Liquidity and Debt Structure

Sufficient Liquidity: As of June 30, 2024, DKL had approximately $825 million in available liquidity. Cash on balance sheet was $5.1 million. The partnership had about $820 million available under its $1.15 billion senior secured revolving credit facility, maturing in October 2027. The credit facility is secured by first priority liens on substantially all of the partnership's and its subsidiaries assets.

The credit facility includes restrictions on total leverage, senior leverage and interest coverage which must remain below 5.25x (5.50x for certain acquisitions), 3.75x (4.0x for certain acquisitions) and above 2.0x, respectively. As of June 30, 2024, DKL was in compliance with its covenants and Fitch expects it to remain in compliance with its covenants through the forecast period.

DKL announced a series of developments on the 2Q24 earnings call which includes the major contract extension with Delek Holdings, the acquisitions of H2O Midstream and indirect interest in Wink-to-Webster pipeline, as well as the construction of a new natural gas plant. These initiatives involve a total cash consideration of about $400 million in 2H24 and are the primary driver of external funding needs.

Debt Maturity Profile: DKL has a maturity wall starting 2027. The revolver ($330 million as of June 30, 2024) matures on Oct. 13, 2027. The unsecured notes are due in June 2028 ($400 million) and March 2029 ($1.05 billion), respectively.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

MACROECONOMIC ASSUMPTIONS AND SECTOR FORECASTS

Click here to access Fitch's latest quarterly Global Corporates Macro and Sector Forecasts data file which aggregates key data points used in our credit analysis. Fitch's macroeconomic forecasts, commodity price assumptions, default rate forecasts, sector key performance indicators and sector-level forecasts are among the data items included.

ESG Considerations

Delek Logistics Partners, LP has an ESG Relevance Score of '4' for Group Structure due to {DESCRIPTION OF ISSUE/RATIONALE}, which has a negative impact on the credit profile, and is relevant to the rating[s] in conjunction with other factors.

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision.