Fitch Ratings has assigned a Long-Term Issuer Default Rating (IDR) of 'B-' to Martin Midstream Partners, L.P. (Martin).

Fitch has also assigned Martin's proposed second lien notes a rating of 'B'/'RR3'. The notes are co-issued by Martin Midstream Finance Corp. The Rating Outlook is Stable.

The ratings are primarily based on Fitch's expectation that approximately 70%-75% of the run-rate EBITDA will be derived from fixed-fee contracts, many of which are with third party customers with whom Martin has maintained a longstanding relationship. Concerns include exposure of the majority of EBITDA to volumetric risks; about 25%-30% of the EBITDA is related to commodity price relationships, which have historically been volatile; and tight covenants in the revolving credit facility could limit liquidity.

Fitch has reviewed preliminary terms for the proposed transactions, and the assigned ratings assume no material variations in the final terms.

Key Rating Drivers

Limited Size and Scope: Martin's size is generally consistent with IDRs in the 'B' range in Fitch's midstream coverage. Small midstream companies generally do not have as many 'tools' for managing through down-cycles as larger companies. Somewhat offsetting its small size are location and segment diversity. The majority of Martin's operations are located along the coast of Texas and Louisiana. This region contains the world's leading array of petrochemical facilities. Many of the services Martin provides have a connection to these facilities. The company also has three large segments (out of four in total) that provide some business diversity.

Cashflow Stability: Martin's 70-75% of the EBITDA comes largely from short-term fixed-fee contracts. Approximately 10%-12% of the overall EBITDA comes from minimum volume commitment (MVC) contracts. Short-term contracts with limited MVCs exposes the company to re-contracting and volumetric risks.

These risks are somewhat reduced by Martin's nearly 20-year long relationship with high-quality top customers that are expected to drive roughly over 60% of the EBITDA. Martin's fee-based businesses provide protection against commodity price exposure. About 25%-30% of the EBITDA is exposed to commodity price relationships and has been subject to thin profitability in some quarters. Volumetric and commodity price exposures lead to considerable cash flow volatility.

Financial Flexibility: Fitch's forecast for the company incorporates the Fitch price deck and other viewpoints that form the basis of a reasonable forecast. Fitch forecasts that most, but not all, of the commitment under the revolving credit facility will be usually be available. The revolver is largely the company's only source of liquidity. Martin's liquidity needs are somewhat reduced by its exit from the butane business, the long-dated maturity of the revolver, and the proposed second lien notes due 2027 and 2028 respectively. Fitch expects the company to have sufficient liquidity in the medium term, which will be important to execute on the base business and prudently grow.

Parent Subsidiary Relationship: In applying Fitch's criteria entitled 'Parent and Subsidiary Linkage Rating Criteria', Fitch identifies that Martin's general partner is, under the criteria, the company's parent. Fitch evaluates the group's consolidated profile to be approximately similar to the issuer's Standalone Credit Profile (SCP). Accordingly, the company's IDR is arrived at without reference to Linkage Factors.

Derivation Summary

Martin is somewhat unique relative to Fitch's midstream coverage given its diversification along the midstream value chain. Medallion Gathering and Processing, LLC (Medallion; B+/Stable) is a small midstream company like Martin but does not have the same diversification.

While both companies have some customers which provide MVCs, the amount of contribution to the overall EBITDA is small. Therefore, both Martin and Medallion have high volumetric risks. Martin's comparatively shorter-term nature of contracts is somewhat offset by its long-term relationship with top customers, but it still has higher re-contracting risks than Medallion. Unlike Medallion, a sizeable portion of Martin's EBITDA is exposed to margins on commodity prices leading to higher cash flow volatility. In addition, compared to Medallion, Fitch estimates Martin to have tighter financial flexibility.

Rockpoint Gas Storage Partners, LP (ROCGAS; B-/Stable) is a regionally concentrated natural gas storage provider in Alberta, which buys natural gas in summer and sells it in winter, similar to Martin's propane business. Both Martin and ROCGAS are regionally concentrated small-scale midstream providers. Martin's business diversification with a reasonable portion of EBITDA under fixed-fee contracts leads to comparatively lower cash flow volatility. In contrast, ROCGAS hedges its open position on natural gas and exhibits better financial flexibility. Therefore, they have similar credit profiles.

Key Assumptions

Oil and gas activity levels in the U.S. Gulf coast consistent with Fitch's base case West Texas Intermediate (WTI) oil price assumption of USD81/bbl in 2023, falling to USD50/bbl by 2025;

Successful extension of the first lien secured revolver and refinancing of the 1.5 lien and second lien secured notes;

A successful exit from the Butane Optimization business in 2023;

Base interest rate for the credit facility reflects the Fitch Global Economic Outlook, e.g., 5% for 2023 and 3.5% for 2024;

Dividends over the forecast period remain consistent with the current levels;

Growth and maintenance capital consistent with management guidance;

The recovery analysis assumes that Martin Midstream Partners, LP. would be reorganized as a going concern in bankruptcy. Fitch has assumed a 10% administrative claim (standard). The going-concern EBITDA estimate of $85 million reflects Fitch's view of a sustainable, post-reorganization EBITDA level upon which we base the valuation of the company. As per criteria, the going concern EBITDA reflects some residual portion of the distress that caused the default;

Fitch used a 6x EBITDA multiple to arrive at Martin's going-concern enterprise value. The multiple is in line with recent reorganization multiples in the energy sector. There have been a limited number of bankruptcies and reorganizations within the midstream space but in the limited sample such as bankruptcies of Azure Midstream and Southcross Holdco, the reorganization multiples were between 5x and 7x by Fitch's best estimates. In Fitch's recent bankruptcy case study report 'Energy, Power and Commodities Bankruptcies Enterprise Value and Creditor Recoveries,' published in September 2021, the median enterprise valuation exit multiplies for 51 energy cases for which this was available was 5.3x, with a wide range of multiples observed.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

EBITDA Interest Coverage above and expected to sustain above 3.0x;

EBITDA Leverage below and expected to sustain below 3.5x;

Material change to cash flow stability profile or a greater proportion of EBITDA derived from long-term MVC type contracts.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

EBITDA Interest Coverage sustained below 2.0x;

EBITDA Leverage sustained above 5.0x;

Weakening of the liquidity profile.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Sufficient Liquidity: The company is expected to have approx. $0.5 million cash and roughly $110 million available under the $200 million revolver (net of letters of credit) pro forma for the proposed transactions. The revolver commitment will step down to $175 million on June 30, 2023 and further to $150 million on June 30, 2024. The extended revolver will mature in 2027 and will have a $50 million accordion. Martin's proposed new $400 million second lien notes will mature in 2028.

Covenants on the new credit facility permit a maximum total leverage of 4.75x at the end of each quarter until Dec. 31, 2024, and 4.5x thereafter; a maximum first lien leverage of 1.5x; and a minimum interest coverage of 2.0x. Fitch expects Martin to remain compliant with the covenants in the medium term.

Issuer Profile

Martin is a publicly traded (NASDAQ: MMLP) limited partnership that owns and operates midstream assets primarily in the Gulf coast region of USA.

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