Fitch Assigns MEG Energy Corp First-Time Rating of 'B'; Outlook Negative

CHICAGO--()--Fitch Ratings has assigned a first-time Long-Term Issuer Default Rating (IDR) of 'B' to MEG Energy Corp.

Approximately CAD $4.9 billion (USD $3.8 billion) is affected by today's rating action. A full list of rating actions follows at the end of this release.

The Rating Outlook is Negative.

KEY RATING DRIVERS

MEG's 'B' rating reflects its ample liquidity and manageable maturity profile, improving cost structure, and long-lived asset base. These considerations are offset by an elevated near-term leverage profile, single project concentration, and reduced cash flows related to the current commodity price environment. The Negative Outlook reflects Fitch's concern around MEG's ability to implement meaningful balance sheet debt reduction in a lower priced oil environment or absent a sale of the Access Pipeline.

AMPLE LIQUIDITY THROUGH 2019

As of Sept. 30, 2016, MEG had CAD $103 million of cash and an additional undrawn CAD $3.3 billion (USD $2.5 billion) revolving credit facility that matures November 2019. The company's debt is covenant lite and the credit facility is not linked to a borrowing base. MEG's earliest maturity is its secured term loan which currently has CAD $1.6 billion outstanding with a maturity date of March 31, 2020. Management is committed to reducing leverage and Fitch expects MEG to fund future developments within cash flows.

PRODUCTION GROWTH RESUMES IN 2018

MEG is currently focused on two lower cost growth projects that should increase cash flows and lower fixed costs per incremental barrel. The two projects combined will add approximately 30 mboe/d to production, bringing total production to around 110 mboe/d by 2020. The enhanced Modified Steam And Gas Push (eMSAGP) project is expected to add 15 to 20 mboe/d to production and the brownfield expansion on Phase 2B is expected to add 13 mboe/d to production, effectively deleveraging the company through increased volumes and cash flows. Fitch's base case expects this development capital will be funded with operating cash flow and possible pipeline proceeds. In the event that the pipeline sale does not go through, Fitch expects that MEG would focus on eMSAGP while remaining cash flow neutral.

REDUCED OPERATING AND CAPITAL EXPENSES

MEG has been successful in reducing their net operating expenses quarter over quarter, helping to lower their cash breakeven price. Operating costs, net of power revenue, fell from CAD $9.69/bbl in the nine months ended third quarter (Q3) 2015 to CAD $7.89 in the nine months ended Q3 2016. MEG has stated that their operating breakeven WTI price fell from USD $37/bbl in 2015 to USD $32/bbl in Q3 2016. In addition to improving their operating cost structure, the company has also reduced their capital spending significantly. Management is currently targeting capex of CAD $140 million for 2016, which is almost 60% lower than their previous guidance given in December 2015. The company was able to reduce capex by deferring some growth projects as well as realizing efficiency gains from their eMSAGP process.

HEDGE PROGRAM INITIATED IN Q1 2016

In the first quarter of 2016, MEG initiated a hedge program to help protect their liquidity and provide cash flow stability. Currently the company has fixed hedges in place for WTI and the WCS differential as well as WTI collars. As of Q3 2016, the company has hedged around 38% of their Q4 2016 blend sales as well as around 40% of their condensate purchases through the rest of 2016. Assuming annual production of 80 to 83 mboe/d, roughly 40% of their remaining condensate purchases for 2017 are hedged. The company is currently focused on the next six to 12 months for hedging activity but Fitch expects the company to increase hedge positions further out if given the opportunity.

ELEVATED NEAR TERM LEVERAGE

MEG's latest 12 months (LTM) debt/EBITDA increased to 27.4x in Q3 2016, up significantly from 4.5x at 2014 year-end (YE). This was driven in a large part by the commodity price decline which reduced EBITDA from CAD $970 million in 2014 to CAD $181 million as of LTM Q3 2016. While LTM leverage is significantly above mid-cycle levels, Fitch expects it will decline considerably and fall within tolerances for the rating category by Fitch's midcycle year of 2018, due to the combination of higher oil prices, growth in production, and deleveraging funded in part by the Access pipeline sale. Under Fitch's base case price assumptions leverage is expected to fall to 5.8x in 2018.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for MEG include:

--WTI oil price of USD $42/bbl in 2016, USD $45/bbl in 2017, USD $55/bbl in 2018, USD $60/bbl in 2019 to USD $65/bbl long term;

--Foreign exchange rate movements linked to oil price changes;

--Flat near term production, with growth resuming in 2018 based on an increasing capital budget and near term project completions;

--Capex of CAD $140 million in 2016, projected to increase as capital projects are deployed;

--Access pipeline sale in 2018 in the range of CAD $1.0 billion to CAD $1.4 billion, with proceeds used to reduce debt and fund production growth.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

For an upgrade to 'B+':

--Material reductions in balance sheet debt, leading to lower through-the-cycle leverage metrics;

--Year-over-year production growth, with capex funded in a credit-neutral manner;

--Mid-cycle debt/EBITDA projections below 4.0x;

--Mid-cycle debt (USD)/flowing barrel less than $35,000.

Fitch does not anticipate a positive rating action in the near term given the elevated near-term leverage profile.

Removal of Negative Outlook:

--Repayment of a significant portion of the Term Loan prior to the maturity of the credit facility, or other deleveraging activity.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

For a downgrade to 'B-':

--Liquidity of less than CAD $2.0 billion;

--Mid-cycle FFO fixed charge coverage below 2.0x;

--Mid-cycle debt/EBITDA projections over 6x;

--Debt (USD)/flowing barrel greater than $50,000.

FULL LIST OF RATING ACTIONS

Fitch has assigned the following first-time ratings:

MEG Energy Corp.

--Long-Term IDR 'B';

--Senior secured bank facility 'BB/RR1';

--Senior secured term loan 'BB/RR1';

--Senior unsecured notes 'B/RR4'.

The Rating Outlook is Negative.

Summary of Financial Statement Adjustments

Fitch has made no material adjustments that are not disclosed within the company's financial statements.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 21 Nov 2016)

https://www.fitchratings.com/site/re/890199

Additional Disclosures

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https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1016119

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1016119

Endorsement Policy

https://www.fitchratings.com/regulatory

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Contacts

Fitch Ratings
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Colin Cordes
Associate Director
+1-312-368-3120
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Brad Bell, CFA
Associate Director
+1-312-368-3149
or
Committee Chairperson
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Senior Director
+1-312-368-2090
or
Media Relations:
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Contacts

Fitch Ratings
Primary Analyst
Colin Cordes
Associate Director
+1-312-368-3120
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Brad Bell, CFA
Associate Director
+1-312-368-3149
or
Committee Chairperson
Mark Sadeghian, CFA
Senior Director
+1-312-368-2090
or
Media Relations:
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com