CHICAGO--(BUSINESS WIRE)--Fitch Ratings has downgraded Hess Corporation's (NYSE: HES) Issuer Default Rating (IDR) to 'BBB-' from 'BBB' and revised the Rating Outlook to Stable from Negative.
Pro forma for October debt repurchases and redemptions, approximately $6.1 billion of Hess debt is affected by today's rating action, excluding non-recourse debt at Hess Infrastructure Partners (HIP).
The downgrade reflects the loss in size and diversification seen at the company over the last few years due to asset sales, including the most recent sale of 50% stake in HIP; YTD negative FCF of -$1.6 billion which has now approximately offset the company's earlier equity and convertibles raise; and limited production growth prospects in the near to medium term, which are expected to keep projected credit metrics weak for the 'BBB' category.
The Rating Outlook is Stable.
A complete list of rating actions follows at the end of the release.
KEY RATING DRIVERS
Hess' ratings are supported by the company's ample liquidity (approximately $8.1 billion at Sept. 30); manageable maturity wall following recent refinancing activity; high exposure to liquids (approximately 74% of 2015 production and 76% of reserves); track record as one of the better operators in the space; as well as decent size and scale as an independent. The Liza prospect in Guyana is likely to be needle-moving over the longer-term but provide limited uplift to the company's credit profile in the near term.
REDUCTION IN DIVERSIFICATION AND SIZE
Hess has lost considerable diversification through the sale of downstream, midstream and retail assets, and most recently, the sale of its 50% interest in Hess Infrastructure Partners (HIP) in the Bakken to Global Infrastructure Partners for $2.6 billion. The company has aggressively pruned a large number of assets as part of earlier restructurings (approximately $9.1 billion since 2009 as calculated by Fitch). This may limit the amount it could liquidate under a lower-for-longer scenario without unfavorably impacting credit metrics.
Asset sales have also impacted the company's size. As recently as 2012, total production was over 400,000 boepd; 2016 production is expected at the 315,000-325,000 boepd due to the asset sales, as well as management's decision to hold off developing reserves until higher oil prices return. Fitch expects the company's production growth to be modest over next three years when compared to peers. As stated earlier, Liza will likely move the needle on production and reserve growth but is unlikely to ramp up in a large-scale way in the near to medium term. Fitch expects Hess' deconsolidated debt/flowing barrel of production will average approximately $21,500/barrel over the next three years.
FREE CASH FLOW (FCF) TRENDS
As calculated by Fitch, Hess' LTM FCF at Sept. 30, 2016 was approximately -$1.9 billion, comprised of capex of $2.7 billion, cash flow from operations of $1.1 billion, and dividends of $332 million. At Sept. 30, consolidated debt/EBITDA (which included $683 million of non-recourse debt of Hess Infrastructure Partners) was 4.7x and EBITDA/interest coverage was approximately 4.0x. On a pro forma basis, using Fitch's recent base case oil price assumptions ($42/bbl in 2016, $45/bbl in 2017, $55/bbl in 2018, and $60/bbl in 2019), Hess' debt/EBITDA leverage is expected to decline to 3.0x in 2017 and 2.3x in 2018 (2.8x and 2.1x on a deconsolidated basis), which is consistent with an investment grade rating.
STRONG OPERATIONAL TRACK RECORD
As calculated by Fitch, Hess has been a solid performer in the independent E&P space, with a consistent track record of strong reserve growth at economical replacement costs, which are key indicators of health for an E&P company. Excluding 2015 results (which were distorted by large price-driven negative reserve revisions), Hess' long term full cycle netbacks averaged approximately $20/boe and organic reserve replacement averaged approximately 129%, both respectable numbers. Hess' 2015 reserve life shrank to 7.8 years from 11.7 years in 2014, but Fitch expects this will rise as incremental reserves are rebooked in a rising price environment and the ratio begins to benefit from rebased production numbers.
Hess continues to make decent progress moving down the cost curve, with recent Bakken completions at less than $4.7 million per well, down 11% from year ago, and 65% below 2012 levels; this lower cost includes a higher 50 frac stage well level versus the previous 35 frac stage design, which the company is planning to extend across the play. Despite its drop in size, Hess still has good geographical diversity, with core positions in onshore shale (Bakken, Utica); offshore GoM; the North Sea; Southeast Asia; and offshore West Africa. Several of these regions are PSC regimes (Production Sharing Contracts) that offer a partial cash flow hedge in lower priced environment (PSCs include North Sea, SE Asia). Hess also has a track record as one of the more successful independent E&Ps in the exploration space, highlighted by its most recent success in offshore Guyana (Liza).
STRATEGIC TRANSFORMATION COMPLETE
Hess has completed its transition to a pure play E&P company from a small integrated oil company, with its earlier exit from refining and trading, the sale of its retail business for $2.8 billion in September of 2014, and the sale of a 50% stake of its Bakken Midstream to GIP for $2.6 billion in mid-2015. The last major item left is an IPO of the equity stake in the Bakken midstream master limited partnership (MLP), which has been delayed due to market conditions. Total proceeds expected from such an event are relatively small; however, in the future, Fitch expects the MLP is likely to provide an ongoing valuable source of liquidity to Hess parent through dropdowns of logistics assets.
Fitch's key assumptions within its rating case include:
--Base case WTI oil prices of $42/bbl in 2016, $45 in 2017, $55 in 2018, $60 in 2019, and $65 in the long term;
--Stress case WTI oil prices of $40/bbl in 2016, $35 in 2017, and $40 thereafter;
--Base case natural gas prices of $2.35/mcf in 2016, $2.75 in 2017, $3.00 in 2018 and 2019, and $3.25/mcf in the long term;
--Stress case natural gas prices of $2.30/mcf in 2016, $2.00 in 2017, $2.25 in 2018, $2.35/mcf in 2019, and $2.50 in the long term;
--Base case production growth increasing just under 7% cumulatively from 2016 to 2019;
--Stress case production growth increasing by 1.3% cumulatively from 2016 to 2019;
--Capex of approximately $2.3 billion in 2016;
--3% dividend growth and no asset sales in the Base case
Positive: Future developments that could individually or collectively lead to positive rating actions include:
--Restored operational momentum, resulting in increased production, size, and reserve growth;
--Sustained debt/EBITDA below 2.0x-2.5x;
--Sustained debt/flowing barrel < $18,000.
Negative: Future developments that could lead to negative rating action include:
--Further decline in size and scale resulting in loss of operational momentum;
--Sustained debt/EBITDA above approximately 3.0x;
--Sustained debt/flowing barrel > $23,000.
Hess' liquidity is very strong. Total liquidity at Sept. 30 was approximately $8.1 billion (including $625 million subsequently used for debt repayment) comprised of approximately $3.5 billion of cash; $4 billion in undrawn revolver, and another $623 million in committed lines. HIP has a separate $400 million revolver that is non-recourse to Hess with availability of $304 million.
Hess' main financial covenant is a maximum debt-to-capitalization ratio of 62.5% contained in its revolver, and the company had ample headroom on this at Sept. 30, 2016 at 26%. Covenant restrictions across Hess' debt instruments are light. There are no financial covenants beyond the debt-to-cap covenant. Other non-financial covenants contained in the bond indentures include restrictions on mergers and asset sales, limitations on sale leasebacks and cross default provisions.
Hess' maturity wall is manageable and has been further pushed out following the company's $1.5 billion September bond offering and subsequent debt tenders.
Hess' other obligations are manageable. Hess' qualified pension was underfunded by $115 million at year-end (YE) 2015, versus an underfunding level of $199 million the year prior. The main drivers of the improvement were actuarial gains, partly offset by lower returns on plan assets. For 2016, expected pension contributions were $27 million, of which $19 million had been paid as of Sept. 30. Hess' Asset Retirement Obligation (ARO) linked to environmental remediation stood at approximately $2.1 billion at Sept. 30, down slightly y-o-y.
FULL LIST OF RATING ACTIONS
Fitch has taken the following rating actions:
--Long-Term Issuer Default Rating (IDR) downgraded to 'BBB-' from 'BBB';
--Senior unsecured notes/debentures to 'BBB-' from 'BBB'
--Senior unsecured revolver to 'BBB-' from 'BBB'.
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 at 'www.fitchratings.com'.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
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