CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Unit Corporation's (Unit; NYSE: UNT) ratings as follows:
--Long-term Issuer Default Rating (IDR) at 'BB';
--Bank revolver at 'BB';
--Senior Subordinated Notes at 'BB-'.
Approximately $645.7 million of debt is affected by today's rating action.
The Rating Outlook is Stable.
KEY RATING DRIVERS
Unit's ratings reflect the company's, increasing exposure to liquids, strong reserve replacement history, modestly diversified business mix (with about 30% of EBITDA coming from non- exploration & production [E&P] segments), rig fleet repositioning efforts, and manageable leverage levels (Fitch calculated debt/EBITDA of 1.0x as of Dec. 31, 2013). These considerations are offset by the relatively small size of its proved reserve base and production profile, as well as some risk of obsolescence within its onshore rig fleet.
The E&P segment (about 70% of EBITDA) reported net proved reserves of 159.9 million barrels of oil equivalent (MMboe) and production of 45.8 thousand boe per day (Mboepd) for year-end 2013. This results in a reserve life of nearly 10 years. UNT has increased production by a 13.4% CAGR and improved its liquids mix to 43.5% from 27.4% over the past five years due to the ability to exploit unconventional reserves within its Granite Wash, Mississippian, Marmaton, and Wilcox plays. The Fitch-calculated three-year average organic reserve replacement and FD&A cost are competitive at 149%, consistent with management's 150% target, and $19.94/boe, respectively.
The contract drilling segment (nearly 25% of EBITDA) reported a 12% reduction in revenue per day to $17,486, excluding intercompany revenue (roughly 10%-15% of drilling activities), with a corresponding decline in the Fitch-calculated rig day margin, excluding intercompany operations, to 40% in 2013 from 46% in 2012. Utilization rates declined for a second consecutive year to 52% primarily attributable to continued industry-wide drilling efficiency gains and company-specific asset quality and mix issues. Management indicated that 78% of its 45 1,200-1,700hp rigs were currently under contract, illustrating the legacy rig overhang on the drilling segment's results.
CONTINUED LIQUIDS & PRODUCTION GROWTH
Unit continued to ramp-up its E&P drilling program, mainly within its liquids-rich Anadarko Basin acreage, to 180 gross wells in 2014 from 149 gross wells (91 net wells) in 2013 by spending $718 million, a 31% year-over-year increase. Management expects this to result in a 15%-18% increase in 2014 production to 19.2-19.7 MMboe in 2014 with liquids comprising 44%-46% of the total. Fitch believes that the execution risk associated with the heightened levels of development is offset by the company's strong operating history within each respective play and cash flow diversification.
FAVORABLE RIG-FLEET REPOSITIONING
The company is actively repositioning its drilling fleet through asset divestitures, retrofits/upgrades, and new-builds to better align with E&P demand for efficient, horizontal/directional drilling rigs within the 1,000-1,500hp range. Unit has sold a total of nine older, larger drilling rigs since 2013 with plans to continue divesting assets, primarily within its smaller less than 600hp rig fleet. The new BOSS drilling rig was rolled out in first quarter 2014 (1Q'14) and designed to serve the horizontal/directional drilling segment with three additional BOSS rigs scheduled to be delivered in 2H'14. Management plans on contracting future BOSS rigs prior to ordering. Fitch views the repositioning effort favorably and expects the rig asset quality and mix improvements to alleviate the contract drilling segment's downward pressure on EBITDA by stabilizing utilization and day rates. However, Fitch believes that it will be a challenge to overcome the first-mover advantage established by larger drilling peers.
LEVERAGE LEVEL SUPPORTS THE RATING
Management's current leverage levels provide financial flexibility to pursue measured oil & gas production growth and rig fleet initiatives. The manageable leverage is evidenced by the company's strong debt/proven (1p) reserves of approximately $4/boe and debt per flowing barrel of nearly $14,100 despite the allocation of all outstanding debt to the E&P segment. Fitch's base case forecasts Unit will be about $200 million free cash flow (FCF) negative in 2014 with a similar profile in 2015, using Fitch's oil & gas price deck, as Unit maintains a heightened level of E&P activity and constructs additional BOSS rigs. Fitch expects the 2014 shortfall to be partially funded with asset divestitures and the remainder credit facility financed. Fitch's base case results in debt/EBITDA of 1.0x in 2014 with debt/1p and debt per flowing barrel remaining relatively flat at under $4.25 and $14,200, respectively. Fitch believes that leverage metrics may experience some upward pressure into the 1.0x-1.1x range in 2015, but not a material deviation from historical and forecasted 2014 levels.
Unit utilizes a combination of swap and collared hedges to manage cash flows and support development funding. As of Dec. 31, 2013, the company's 2014 oil and gas hedges accounted for 75% and 58%, respectively, of its 4Q'13 production.
ADEQUATE LIQUIDITY POSITION
UNT has historically maintained a nominal cash balance and had approximately $18.6 million of cash-on-hand as of Dec. 31, 2013. The company's primary source of liquidity is its $500 million senior unsecured credit facility due Sept. 2016. The revolver had no outstanding borrowings at year-end 2013. The capacity of the revolver may be increased, at management's election, up to a value consistent with the company's borrowing base ($800 million as of Dec. 31, 2013). The borrowing base is re-determined semi-annually based on the present value of oil and gas reserves and midstream cash flows, subject to a maximum credit facility size of $900 million.
Financial covenants, as defined in the credit facility agreement, require Unit to maintain a current ratio above 1x and debt/EBITDA below 4x. Other covenants across UNT's debt instruments consist of dividend restrictions (less than 30% of the preceding year's consolidated net income), additional debt (EBITDA/interest above 2.25x, subject to an investment-grade rating of the notes) and lien limitations, transaction restrictions, and change in control provisions. As of Dec. 31, 2013, Unit was in compliance with and had considerable headroom within all of its covenants. The company has a long-dated maturity profile with its senior subordinated notes maturing in May 2021.
LIMITED OTHER LIABILITIES
Unit does not have a defined benefit pension plan. Asset retirement obligations (AROs) were $134 million, as of Dec. 31, 2013, which is below the $146 million reported at year-end 2012 mainly due to a revision of cost estimates associated with plugging wells based on actual costs over the preceding year. The company does not have any material additional liabilities.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Increased size, scale, and diversification of Unit's E&P operations;
--Heightened rig utilization and day rates signalling an improvement in asset quality and mix;
--Maintenance of debt/EBITDA and debt/flowing barrel of 1.0x-1.25x and below $15,000, respectively.
Future positive rating actions are unlikely without a material increase to the company's reserve base and production profile, in conjunction with the maintenance of strong leverage metrics.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--Debt/EBITDA of 1.5x-1.75x on a sustained basis;
--Debt/flowing barrel approaching $20,000;
--A persistently weak oil & gas pricing environment without a corresponding reduction to capex;
--Further material declines in rig utilization and day rates.
Future negative rating actions will be closely linked to the company's ability to maintain manageable leverage levels while pursuing its E&P growth targets, as well as the repositioning of its rig fleet and development of its midstream footprint.
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);
--2014 Outlook: North American Oil & Gas (Dec. 12, 2013);
--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).
Applicable Criteria and Related Research:
Energy Handbook -- Upstream Oil & Gas
Investor FAQs: Recent Questions on the E&P, Refining, and Drilling and Services Sectors
Full Cycle Cost Survey for E&P Companies (2012 Numbers Up, but Adjustments Tell a Different Story)
2014 Outlook: North American Oil & Gas (Strong Oil Prices Continue to Support Energy Complex)