OREANDA-NEWS. S&P Global Ratings said today that it assigned its 'B+' corporate credit rating to Gulf Finance LLC. The outlook is stable. We also assigned our 'BB-' issue-level rating to the company's proposed $1.2 billion senior secured term loan B.

The recovery rating on the term loan B is '2', indicating our expectation for substantial (70% to 90%; lower half of the range) recovery in a default scenario.

The 'B+' rating reflects a fair business risk profile and a highly leveraged financial risk profile.

The fair business risk profile is based on Gulf Finance's relatively strong market position, increased scale, and the long tenor of its counterparties, but offset by limited contract life on storage facilities and relatively limited diversity. In the storage and transportation businesses, we see contract lives that are generally under one year, which contrasts with more thoroughly contracted issuers. We anticipate that the combination of the businesses will provide some level of cost synergies and make the new operation somewhat more efficient by 2017, noting that these are highly complementary assets.

The highly leveraged financial risk profile is based on debt to EBITDA that we expect to approach 5.5x initially and then remain at about 5x throughout the forecast period. The relatively high amount of leverage initially placed on the issuer could come down over time as a result of the nature of the debt, which includes a 75% cash flow sweep. We believe these ratios embed the risks of underperformance in weak commodity cycles. Additionally, ownership by ArcLight Capital, deemed a financial sponsor under our criteria, may limit the improvement in the financial risk profile over time even with better metrics, depending on what future plans for this entity might be.

The newly formed entity, which will subsume both Penn Products and Chelsea Petroleum Products, will have a significant footprint in the NorthEastern U. S. refined product storage business. Gulf will now participate materially in the storage, transportation, and branded and unbranded sales businesses, and will broaden the geographic spread somewhat, as both were somewhat concentrated before. Gulf will now own 17 terminals, and have about 14 million barrels of storage capacity at close, increasing throughput and volume considerably.

"The new entity's relatively focused geographic scope exposes it to regional economics to a greater degree than a more diversified provider of similar services, and its absence of long-term storage contracts offers less visibility into its cash flows as we get further into our forecast period, introducing considerable recontracting risk if its competitive advantage erodes over time," said S&P Global Ratings credit analyst Michael Ferguson.

Contract lengths vary, with branded contracts having a weighted average of about seven years and unbranded contracts less than one year, while storage and transportation agreements are generally shorter term in nature.

However, Gulf's former subsidiaries have also demonstrated some pricing resiliency with its long-time customers in recent years. Although we have seen considerable fluctuation in oil prices during the past year, the issuer is mostly immune to these due to a hedging strategy that is designed to prevent exposure to a price fluctuations. This has resulted in profitability that has been robust in most years, but can be undercut by lower volumes, which was borne out in late 2015 and early 2016 at the Penn Products level.

Recognizing that EBITDA volatility at certain of the assets has been high historically, the company has mitigated commodity price risk to a degree by hedging its long refined product exposure inherent in its inventory with short front-month futures contracts. Under the new management, Gulf plans to modify its hedging strategy to attempt to reduce further the price volatility, as well as lower its inventory holdings.

The stable outlook on Gulf Finance reflects our expectation that debt to EBITDA will exceed 5x during the next two years, based on relatively stable storage rates and volumes. We anticipate that there will be certain synergies associated with the merger of the combined enterprises.