CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) and other securities ratings of Talisman Energy Inc. (TLM). The Rating Outlook has been revised to Negative from Stable. Fitch affirms the following:
--Long-term IDR at 'BBB';
--Senior unsecured revolvers totaling $3.1 billion at 'BBB';
--Senior unsecured notes at 'BBB';
--Short-term IDR at 'F2';
--Commercial Paper at 'F2';
--Cumulative perpetual preferred stock at 'BB+'.
Approximately $7.6 billion in debt, committed revolvers and preferred stock are impacted by today's rating action. All securities are issued at the parent level, TLM.
Key Ratings Drivers
TLM is trying to move its capital structure towards more conservative financial metrics and maximize cash flow per common share. Recognizing that the company does not have the financial wherewithal to develop and prove all of its oil and gas opportunities, TLM is transitioning its portfolio. It is selling off long-term capital-intensive projects in favor of developing less expensive, shorter term, high-return projects. This should have the effect of increasing cash flow and reducing capital expenditures. TLM's debt target is 1.5x cash flow.
TLM has a strong liquidity profile. Committed revolver facilities at the close of this past second quarter totaled $3.1 billion of which $2.9 billion is fully committed through 2018. At June 30, 2013, $509 million in commercial paper was outstanding under TLM's $1 billion U.S. commercial paper program, and letters of credit totaled $86 million, leaving available borrowing capacity of $2.5 billion. There is only one financial test in TLM's revolvers, a maximum consolidated debt-to-consolidated cash flow from operations ratio of 3.50x. Upcoming debt maturities are light with no significant maturities appearing before the $375 million, 5.125% senior unsecured notes which come due in May 2015.
TLM has strong producing reserve positions, notably Marcellus and the liquids-rich Eagle Ford in the United States, the Corridor and Jambi Merang in Indonesia, South Duvernay and the greater Edson area in Canada. Although the company's reserves were 70% natural gas at last year-end, contractual prices for natural gas in Southeast Asia are tied to crude oil at a premium which increases the percentage of oil-derived revenues and lessens the dependence on commodity gas prices which are trading near five-year lows.
TLM also has a good history of replacing its hydrocarbon production, the exception being 2012. TLM reduced its capital spending plans in the Marcellus shale play and in the North Sea which resulted in write-downs of 91mmboe (million barrels oil equivalent) and 44mmboe, respectively, in those geographies. Excluding 2012, reserve replacement averaged 169.8% during the three prior years.
Lacking the cash flow it once had from its UK drilling operations due to the maturity of the North Sea fields, an aging infrastructure there, and 'not best in class' capital use decisions, TLM must make whole a cash flow deficit caused by an aggressive worldwide development capital budget designed to boost production and prove reserves. Roughly $2 billion-$3 billion in asset sales is expected by mid-2014 but with only $99 million having been accomplished through the close of this past second quarter. Leverage will likely rise, possibly as high as 2.25x debt/EBITDA by the end of 2013, until those sales proceeds are received and are used to repay debt. Delays in the sale of assets, specifically, the Ocensa pipeline and acreage in North Duvernay, the Norwegian North Sea and Montney, could have negative rating implications.
TLM will also need to turn around its North American operations which are suffering from low realizations (owing to low natural gas prices) and high operating costs. Realizations per boe have been rising of late and segment losses have been declining, but cash flow after capital expenditures is still negative and contributing to higher debt levels.
If TLM's turnaround strategy is working, increased production and reserve replacement should be accompanied by some improvement in debt/flowing barrel after asset sales have been completed. A higher figure than the recent past ($13,100/flowing bbl.) adjusted for the Talisman UK (TSEUK) and Equion deconsolidations would suggest a higher leveraging of ongoing operations and a higher risk profile.
The above rating concerns are the basis for the revision in the Rating Outlook to Negative.
In recent six-month comparisons, production from ongoing operations net of royalties fell 14.5%, owing in large measure to TLM's sale of a 49% interest in TSEUK to a subsidiary of Sinopec. Excluding all North Sea operations, production fell 11.7% following reduced capital spending in the Marcellus shale play and Canadian conventional gas fields in favor of an increased focus on the oil-rich Eagle Ford. TLM's netbacks in the first six months of 2013 were 11% higher than the prior year, but EBITDA was down significantly owing to the decline in production volumes. Capital spending was down 35%, but free cash flow (FCF) was -$917 million (compared to -$654 million in the prior half-year's results), and was made whole primarily through additional borrowings ($505 million) and balance sheet cash ($321 million).
A Look Ahead
TLM has lowered their 2013 production guidance. Including their share of pre-royalty production from Equion (a 49% owned joint venture in Colombia) and their 51% interest in TSEUK, TLM expects to produce 375mboe per day, the lower range of their initial production guidance. If no additional asset sales were to occur in the second half of the year and assuming no improvement in North American operating costs, Fitch estimates that leverage could climb to 2.25x EBITDA from 1.10x at the end of 2012 with FCF in excess of -$1 billion.
A significant piece of this increase in leverage could be corrected in 2014 with the sale of $2 billion in assets. Assuming no change from the 2013 capital budget, leverage could retreat to 1.80x without any upside from prices or lower operating costs. At that sustained degree of leverage, however, TLM could be a candidate for a one notch downgrade.
Fitch has affirmed TLM's debt and preferred stock ratings in the belief that the company can maintain financial metrics commensurate with its current ratings and high grade its portfolio of oil and gas properties using capital garnered through asset sales. On an interim basis, leverage may increase until data rooms are opened, and deals are closed.
A sustained increase in debt/proved reserves above $4.50/barrel beyond mid-2014 could indicate some trouble in the liquidity of the assets that TLM is trying to sell. This situation could lead to a negative rating action.
TLM is not likely to see a ratings' upgrade in the immediate future. A positive FCF along with some improvement in leverage and the company's reserve base would be a path to a positive rating action.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Relevant Research:
--'Corporate Rating Methodology Including Short-Term Ratings and Parent and Subsidiary Linkage' (Aug. 5, 2013);
--Treatment and Notching of Hybrids in Nonfinancial Corporate REIT Credit Analysis (December 13, 2012);
--'Full Cycle Cost Survey for E&P Producers-2012 Numbers Up, but Adjustments Tell a Different Story' (May 28, 2013);
--Investor FAQs — Recent Questions on E&P, Refining, and Drilling and Services Sectors (Aug. 12, 2013);
--Energy Handbook — Upstream Oil & Gas (June 28, 2013);
--Corporate Sector Credit Factors (Nov. 23, 2012).
Applicable Criteria and Related Research:
Corporate Sector Credit Factor Guidelines - All Sectors 2012
Investor FAQs — Recent Questions on the E&P, Refining, and Drilling and Services Sectors
Energy Handbook — Upstream Oil & Gas
Full Cycle Cost Survey for E&P Companies (2012 Numbers Up, but Adjustments Tell a Different Story)
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage