Fitch Affirms Devon Energy at 'BBB+'; Outlook Stable.
The rating reflects the company's large North American onshore reserve and production base with considerable higher margin Delaware and STACK growth potential, increasing exposure to liquids, favorable liquidity and maturity profile, conservative financial policy, and robust historical defense of its credit profile. Rating concerns include Canadian heavy oil/bitumen differentials weakness and production profile declines associated with asset sales and lower activity levels. Fitch believes, however, that Devon's liquidity positon, systematic hedging program, and competitive Permian and STACK full-cycle costs mitigate production and operational execution concerns.
KEY RATING DRIVERS
2020 Vision Consistent with Rating: Management has outlined its 2020 Vision that emphasizes key operational and financial tenents established through-the-cycle, including return and cash flow optimization, portfolio simplification, and increased financial strength targeting net debt/EBITDAX of 1.0x-1.5x. Devon has taken steps to execute its goals during 1H18 via the establishment of a $50 oil price-linked capital program, strong operational results - particularly within the Delaware and STACK - announcement of over $4 billion in non-core asset sales, and completion of a roughly $800 million debt tender. The 2020 Vision also outlines a path for increased shareholder returns with excess cash flow via measured share repurchases and dividend growth. Fitch believes the company's 2020 Vision is consistent with the current 'BBB+' rating.
Growing, Liquids-Weighted Core: Devon has a growing, liquids-weighted production profile driven by its core Delaware and STACK positions with 4Q17 exit-to-4Q18 exit growth estimated to be over 40% and around 25%, respectively. Delaware initial production results continue to be robust particularly within development areas along Lea and Eddy counties that are considerably outperforming Permian peer results. STACK results also continue to be strong with the Showboat infill project's strong initial production results, operational efficiency gains, and cost savings demonstrating the return improving opportunities. Fitch believes the company is likely to achieve its production growth targets given strong operational execution and well results with continued opportunities to improve capital efficiency and well returns.
Positive FCF, Strong Metrics: Fitch's base case forecasts Devon, on a standalone basis, will be approximately $600 million FCF positive in 2018. Standalone debt/EBITDA is forecast to improve to approximately 1.7x in 2018 benefiting from higher oil prices and continued higher margin production growth offset by basis differentials weakness. The leverage profile is projected to increase to around 1.9x in 2019 mainly due to Fitch's lower oil price assumptions and the loss of EnLink cash distributions. Standalone debt/proved developed (PD) reserves and debt per flowing barrel metrics are forecast to be approximately $3.60/boe and $10,700, respectively, in 2018.
Systematic Hedge Program: Management has implemented a systematic hedging program, using a combination of swaps and collars, which establishes hedge position targets, subject to hydrocarbon prices, on a rolling six quarter basis. Fitch believes that the systematic hedging program helps mitigate the decision making and pricing effects of market timing via dollar-cost-averaging, which should moderate cash flow variability and support development funding. The hedging program allows for discretionary activity that provides management with an opportunity to act opportunistically.
As of April 27, 2018, oil production was approximately 65% and 35% hedged for 2018 and 2019, respectively, based on 2018 guidance. Natural gas production was about 55% and 20% hedged for 2018 and 2019, respectively, based on 2018 guidance. The company has also taken steps to help offset Midland and WCS basis differentials. Devon reported a derivative liability of $140 million as of March 31, 2018.
Devon is a relatively large independent E&P with a considerable higher-quality U.S. onshore footprint within the growth-oriented, high-return Delaware and STACK; FCF positive Eagle Ford, declining, gas-focused Barnett, and promising Rockies. The company also operates the Jackfish SAG-D Canadian oil sands project, which possess a considerable reserve life and stable production profile. Devon's full-year production guidance is 536-560 thousand barrels of oil equivalent per day (mboepd) in 2018, which is at the upper end of 'BBB'-rated peers Anadarko Petroleum Corp. (BBB/Stable; 658-685 mboepd), Concho Resources Inc. (BBB-/Positive Watch; guidance is for above 300 mboepd pro forma for the RSP Permian transaction), Continental Resource, Inc. (BBB-/Stable; 285-300 mboepd), Marathon Oil Corp. (BBB/Stable; 390-410 mboepd), Noble Energy Inc. (BBB-/Positive; 350-360 mboepd), and Pioneer Natural Resources Co. (BBB/Stable; Permian production of 266-278 mboepd).
Devon's Canadian heavy oil/bitumen production, however, is subject to take-away constraints and quality discounts, that have resulted in relatively weak realized oil prices ($19.74/bbl for Canadian heavy oil/bitumen vs. $62.93/bbl for benchmark WTI during 1Q18) that will take at least a few years to alleviate permanently. This discount, as well as a relatively more gas-oriented U.S. product mix, results in below peer average Fitch-calculated unhedged corporate realized prices and cash netbacks of approximately $27.80/boe (vs. $40.70/boe peer average) and $11.60/boe (vs. $25.70/boe), respectively, for 1Q18.
Management has offset the impact of hydrocarbon price cycles, in addition to below peer average corporate cash netbacks, by aggressively resetting the standalone E&P capital structure to around $6 billion from approximately $10 billion at YE2015. The company's standalone LTM debt/EBITDA metric, as of March 31, 2018, is estimated at around 2x, which is consistent with 'BBB+' rating tolerances. Upstream credit metrics, excluding non-recourse midstream debt, are favourably below peer averages with debt/flowing barrel and debt/PD reserves under $11,300 (vs. below $15,200 peer average) and about $3.50/boe (vs. approximately $6.70), respectively, for 1Q18.
Fitch's key assumptions within our rating case for Devon include:
--WTI oil prices that trend down from $65/bbl in 2018 and $60/bbl in 2019 to a long-term price of $55/bbl;
--Henry Hub natural gas prices of $2.75/mcf in 2018 and $3/mcf thereafter;
--Production of approximately 560 mboepd in 2018 followed by around 10% annual growth for the next several years;
--Liquids mix of 65% or greater throughout the forecast period;
--Standalone capex of approximately $2.4 billion in 2018 followed by mid-single-digit annual increases;
--Completion of $3.125 billion EnLink transaction in 3Q18 and $2 billion of non-core E&P asset sales by mid-2019;
--Execution of $4 billion share repurchase program by mid-2019;
--Measured annual dividend increases consistent with FCF profile;
--No material additional debt reduction.
Developments that May, Individually or Collectively, Lead to Positive Rating Action
--Material increase in size, scale, and diversification of Devon's operations above 750 mboepd with some combination of the following metrics;
--Mid-cycle standalone debt/EBITDA under 1.5x on a sustained basis;
--Mid-cycle standalone debt/flowing barrel below $12,000 or standalone debt/PD under $4.50/boe on a sustained basis.
Developments that May, Individually or Collectively, Lead to Negative Rating Action
--Mid-cycle standalone debt/EBITDA above 2.0x-2.5x on a sustained basis;
--Mid-cycle standalone debt/flowing barrel above $15,000-$17,500 or standalone debt/PD over $5.00-$5.50/boe on a sustained basis;
--Additional equity-friendly actions inconsistent with the forecasted FCF and liquidity profiles.
Adequate Liquidity Position: Cash-on-hand was over $1.4 billion as of March 31, 2018. The company's $3.0 billion syndicated, senior unsecured credit facility (approximately $2.9 billion remains available, net of roughly $51 million in letters of credit outstanding) principally due October 2019 and CP program sized to the credit facility. Fitch believes the company will amend and extend its credit facility over the coming months with no material execution risks anticipated.
The company will also receive $3.125 billion following the sale of its EnLink interests plus around $2 billion in upstream asset sales (nearly $50 million completed as of March 31, 2018; about $1.1 billion announced), which is expected to largely be used to fund the recently upsized $4 billion share repurchase program.
Manageable Maturities Profile: Devon has a manageable maturities profile with approximately $115 million due in 2018, $162 million due in 2019, $500 million due in 2021, and $1 billion due in 2022. Fitch believes the combination of strong operational execution, liquidity, and leverage metrics help mitigate any potential medium-term refinance risks.
Covenant Lite: The main financial covenant, as defined under the credit agreement, is a maximum debt-to-capital ratio of 65% (26.2% as of March 31, 2018). Other customary covenants consist of additional lien limitations, transaction restrictions, and change in control provisions. Notably, 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 help moderate the covenant-related effects of negative hydrocarbon price movements.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Devon Energy Corporation
--Long-term IDR at 'BBB+';
--Senior unsecured credit facility at 'BBB+';
--Senior unsecured notes at 'BBB+';
--Short-term IDR at 'F2';
--Commercial paper program at 'F2'.
Devon Financing Corporation U.L.C.
--Senior unsecured notes at 'BBB+'.
Ocean Energy, Inc.
--Long-term IDR at 'BBB';
--Senior unsecured notes at 'BBB'.
The Rating Outlook is Stable.
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|Publication:||Daily the Pak Banker (Lahore, Pakistan)|
|Date:||Oct 6, 2018|
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