CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned a rating of 'BBB+' to Devon Energy Corp.'s (Devon; NYSE: DVN) $850 million senior unsecured notes. The notes have a 5.85% coupon and maturity date of Dec. 15, 2025. Net proceeds will be used to fund a portion of the recently announced $1.9 billion Anadarko/STACK acquisition and for general corporate purposes.
$2.5 BILLION IN ACQUISITIONS ANNOUNCED
Devon recently announced $2.5 billion in Anadarko/STACK and Powder River Basin (PRB) acquisitions with just under half ($1.15 billion) of the total transaction price to be debt-funded. Fitch estimates pro forma LTM debt/EBITDA will increase to nearly 2.0x from over 1.7x. This excludes EnLink distributions to non-controlling interests and associated non-recourse debt. Management also commenced a non-core asset divestiture program with expected proceeds of $2 billion to $3 billion. Targeted non-core assets include the company's Access Pipeline in Canada and select E&P assets - potentially Carthage, Miss-Lime, Granite Wash and select Midland Basin assets - with production of 50-80 thousand boe per day (mboepd - roughly 50% liquids).
The company is acquiring an acreage position in the Anadarko Basin's oil-weighted STACK play from Felix Energy for $1.9 billion. Devon will purchase 80,000 net acres (adjacent to its existing STACK position) with multiple prospective formation zones and current production of 9 mboepd (30% oil and 40% NGLs). Fitch believes this is an opportunistic acreage acquisition that will not materially add to near-term production and cash flow, but is likely to add value in the future. The transaction is expected to close in early 2016.
The company is also acquiring a 253,000-acre position in the PRB's oil-oriented region (adjacent to its existing PRB position) for $600 million. The largely undeveloped position has multiple pay zones with current production of 7 mboepd (approximately 85% oil). Fitch believes that the PRB acquisition is also an opportunistic acreage acquisition that will not materially contribute to medium-term production and cash flow. Fitch views the PRB as promising, but much earlier in development than the STACK position. The transaction is expected to close by year end.
Fitch expects the acquisitions to be leveraging over the near term, but anticipates management will repay debt in excess of the acquisition debt amount. This should support the near-term credit profile given the acquired assets' earlier stage of development, as well as the prospects for a slower hydrocarbon price recovery. Fitch views Devon's plan to be generally consistent with its 2014 GeoSouthern acquisition. That transaction resulted in a near-term increase in gross debt followed by a series of divestitures that funded debt repayment equivalent to the acquisition debt amount.
The acquisitions are generally viewed as neutral-to-positive, since near-term production and cash flow impacts will be moderate, asset quality is generally being high-graded, and resource positions are becoming more focused and scaled. Fitch recognizes that execution risk associated with planned non-core asset sales remains. However, we believe the risk is manageable given the number of peer and financially-backed E&P companies that have a considerable amount of capital looking to be deployed for M&A, as well as the fact that Devon is likely to have multiple options for generating liquidity to pay down debt if these specific transactions encounter any roadblocks.
KEY RATING DRIVERS
Devon's ratings reflect its large North American onshore reserve and production base, increasing exposure to liquids, and conservative financial policy. Offsetting factors include the potential for a lower-for-longer oil price scenario, execution risk associated with its non-core asset divestiture program and the development of its U.S. onshore reserve base, and a possibility that management accelerates drilling activity ahead of supportive pricing signals. Fitch recognizes, however, that Devon reported favorable year-to-date 2015 exploration and production (E&P) cost improvements, production efficiency gains, and capex reductions that help alleviate our near-term operating and cost concerns. Another consideration is the financial flexibility provided by dropdowns to and unit sales of Devon's EnLink affiliates.
The company reported year-end 2014 net proved reserves of nearly 2.8 billion barrels of oil equivalent (boe) and production of 674 mboepd; (53% liquids). This resulted in a year-end reserve life of over 11 years. Third-quarter 2015 production of 680 mboepd (61% liquids) was largely consistent with the first half of the year. The Fitch-calculated three-year all-in reserve replacement rate was about 78% with an associated finding, development, and acquisition (FD&A) cost of approximately $28.93/boe. Unhedged cash netbacks ($20.68/boe in 2014) have generally exhibited positive trends over the past several years mainly due to increased liquids production. However, materially lower oil prices during the first nine months of 2015 have pushed unhedged cash netbacks sharply lower to approximately $7.28/boe. Notably, the company's solid hedge position provided about $10.12/boe of netback uplift resulting in a hedged cash netback of $17.40/boe.
Latest 12-month (LTM) metrics, as of Sept. 30, 2015, demonstrate the early effects of lower price realizations with consolidated debt/LTM EBITDA increasing to approximately 2.1x from 1.6x at year-end 2014. The Fitch-calculated standalone Devon debt/proved (1p) reserves, debt/proved developed (PD) reserves, and debt/flowing barrel metrics were about $3.30/boe, $4.40/boe, and $13,300, respectively, as of Sept. 30, 2015.
CASH FLOW METRICS WIDEN DUE TO WEAK PRICES
The Fitch base case, assuming West Texas Intermediate (WTI) and Henry Hub prices of $50/barrel and $2.75/mcf, respectively, results in 2015 debt/EBITDA of 1.9x, excluding EnLink distributions to non-controlling interests and associated non-recourse debt. Standalone debt/1p reserves, debt/PD reserves, and debt/flowing barrel metrics are forecast to remain solid at approximately $3.20/boe (subject to price-induced reserve revisions), $4.25/boe, and $13,050, respectively.
Fitch's base case WTI and Henry Hub price forecast assumptions of $50/barrel and $2.75/mcf in 2016, respectively, suggest that Devon will materially reduce capital spending and selectively allocate the majority of capital to its highest return drilling locations. The Fitch base case forecasts that the company's 2016 debt/EBITDA metrics will increase to approximately 2.5x. Fitch assumes management executes planned asset sales and reduces debt in excess of the acquisition debt amount.
Devon maintains a combination of swaps and collars to manage cash flow variability and support development funding in 2015. No oil and gas volumes are currently hedged for 2016.
Fitch's key assumptions within the rating case for Devon include:
--WTI oil price that trends up from $50/barrel in 2015 to a long-term price of $70/barrel;
--Henry Hub gas that trends up from $2.75/mcf in 2015 to a long-term price of $3.50/mcf;
--Oil & gas production of 680 mboepd in 2015, consistent with guidance, followed by relatively flat production in 2016 and modestly higher production thereafter;
--Oil mix increases to 40% in 2015 with ongoing growth thereafter mainly due to a combination of lower natural-gas focused activity (e.g., Barnett) and ongoing development of the Permian and, over the medium-term, Eagle Ford and Anadarko;
--Capital spending of around $4 billion in 2015, generally consistent with guidance, followed by a more balanced capital program and, potentially, some price-induced increases in drilling activity;
--EnLink growth-oriented capital spending and associated distribution improvements assumed throughout the forecast;
--Non-core asset sales at the upper end of management's $2 billion to $3 billion targeted range in 2016 with a large portion of proceeds assumed to be allocated to debt reduction.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Increased size, scale, and diversification of Devon's operations with some combination of the following metrics;
--Mid-cycle debt/EBITDA, excluding EnLink distributions to noncontrolling interests and associated non-recourse debt, under 1.0x - 1.25x on a sustained basis;
--Mid-cycle debt/flowing barrel below $12,000 and/or debt/PD under $4.50/boe, excluding EnLink non-recourse debt, on a sustained basis.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--Mid-cycle debt/EBITDA, excluding EnLink distributions to noncontrolling interests and associated non-recourse debt, of 1.5x-2.0x on a sustained basis;
--Mid-cycle debt/flowing barrel above $15,000-$17,500 and/or debt/PD over $5.00 - $5.50/boe, excluding EnLink non-recourse debt, on a sustained basis;
--A persistently weak oil & gas pricing environment without a corresponding reduction to capex;
--Acquisitions and/or shareholder-friendly actions inconsistent with the expected cash flow and leverage profile.
ADEQUATE LIQUIDITY POSITION; ENLINK PROVIDES ADDED FLEXIBILITY
Cash-on-hand was $1.7 billion as of Sept. 30, 2015. Additional liquidity is provided by the company's $3 billion syndicated, senior unsecured credit facility principally due October 2019 and CP program sized to the credit facility. No CP or credit facility borrowings were outstanding as of Sept. 30, 2015. Fitch notes that the company used a portion of the $750 million 5.0% senior notes issued in June 2015 to repay a portion of the previously outstanding CP balance, but intends to use the net proceeds to repay the $500 million floating rate senior notes due December 2015.
Fitch recognizes that EnLink provides considerable financial flexibility and liquidity potential. Midstream MLPs tend to be more resilient than E&P in oil & gas price down cycles, particularly when their contract mix is weighted towards long-term, fee-based contracts. However, the prospects for a persistently low hydrocarbon price environment has generally softened midstream equity market prices year-to-date, which may reduce the near-term attractiveness of EnLink funding. About 80% of EnLink cash flows are fee-based with Devon contracts representing a significant portion.
MANAGEABLE MATURITIES PROFILE AND LEVERAGE COVENANT
The company has a manageable maturities profile with $500 million, $350 million, $875 million, and $700 million due in 2015, 2016, 2018, and 2019, respectively. These maturities represent the company's floating rate notes due December 2015 and 2016, 8.25% senior notes due July 2018, 2.25% senior notes due December 2018, and 6.30% senior notes due January 2019. Devon addressed its 2015 floating rates note maturity with its $750 million debt issuance in June 2015.
The main financial covenant, as defined under the credit agreement, is a maximum debt-to-capital ratio of 65% (21.9% as of Sept. 30, 2015). Other customary covenants consist of additional lien limitations, transaction restrictions, and change in control provisions. Fitch notes that total capitalization, as defined in the financial covenant, is adjusted to add back noncash financial write-downs (e.g. full cost ceiling impairments or goodwill impairments) that will help moderate the covenant-related effects of the downcycle.
Devon's defined benefit pension plan was about $228 million underfunded, equal to an 83% funded status, at year-end 2014. Fitch believes that the expected size of service costs and contributions is manageable relative to fund flows from operations. Other contingent obligations total approximately $13 billion on a multi-year, undiscounted basis mainly comprising purchase obligations ($5.3 billion, subject to condensate market prices), operational agreements ($5.1 billion), asset retirement obligations ($1.4 billion), drilling and facility obligations ($446 million), and lease obligations ($405 million).
Purchase obligations are primarily related to contractual commitments to purchase condensate to blend with its Canadian heavy oil production and facilitate transportation. Fitch believes the contracts help to mitigate volumetric procurement and heavy oil transportation risks while limiting contractual price risk via contractual market price provisions. Operational agreements represent midstream fixed-fee arrangements with about 40% related to commitments between Devon and EnLink.
FULL LIST OF RATING ACTIONS
Fitch currently rates Devon Energy Corp. and its affiliates as follows:
Devon Energy Corporation
--Long-term Issuer Default Rating (IDR) 'BBB+';
--Senior unsecured notes 'BBB+';
--Senior unsecured credit facility 'BBB+';
--Short-term IDR 'F2';
--Commercial paper 'F2'.
Devon Financing Corporation U.L.C.
--Senior unsecured notes 'BBB+'.
Ocean Energy, Inc.
--Long-term IDR 'BBB';
--Senior unsecured notes 'BBB'.
Fitch has assigned the following rating:
Devon Energy Corporation
--Senior unsecured notes at 'BBB+'.
The Rating Outlook is Stable.
Date of Relevant Rating Committee: Dec. 7, 2015
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 07 Dec 2015)