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 March 27, 2015 - 9:17 AM EDT
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Fitch Affirms Unit Corporation's IDR at 'BB'; Outlook Stable

Fitch Ratings has affirmed all ratings for Unit Corporation (Unit; NYSE: UNT) with a Stable Rating Outlook.

Approximately $812 million of debt is affected by today's rating action. A full list of rating actions follows at the end of this release.

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 rationalization and repositioning efforts, midstream footprint with an increasingly fee-based contract mix, and manageable leverage levels. These considerations are offset by the relatively small size of its proved reserve base and production profile, continued risk of obsolescence within its onshore rig fleet, and impact of significantly weaker oil prices on cash flows.

The E&P segment (about 70% of EBITDA) reported net proved reserves (1p) of 179 million barrels of oil equivalent (MMboe; 76% developed) for the year-ended 2014 and production of 50.1 thousand boe per day (Mboepd; 46.3% liquids mix), a 9% year-over-year increase, as of Dec. 31, 2014. This results in a reserve life of nearly 10 years. One-year organic reserve replacement was strong at 210%, relative to a three-year average of 174% and management's target of 150%, with an associated Fitch-calculated finding and development (F&D) cost of just $17.81/boe. The company's operational metrics highlight its shift to unconventional drilling, benefits of shale-linked efficiency gains, and improving liquids mix.

The contract drilling segment (nearly 25% of EBITDA) reported a modest reduction in revenue per day to $17,318, excluding intercompany revenue (roughly 10%-15% of drilling activities), but the Fitch-calculated rig day margin, excluding intercompany operations, improved by 4% to $7,328 mainly due to the placement of higher margin, new BOSS rigs into service during the second half of 2014. Utilization rates in 2014 increased to 63% benefiting from the increase in U.S. onshore activity, as well as the sale of four larger, idle rigs in the first quarter and removal of 31 older, non-core rigs from service in late December. The rapid decline in the average number of active Unit rigs from 80.9 during the fourth quarter of 2014 to 37 rigs as of March 24, 2015 illustrates the rapid industry-wide release of U.S. onshore rigs. Fitch believes that Unit's asset quality and mix issues may compound the effects of the downcycle with some offset provided by the four working and an additional four to be delivered BOSS rigs.

Credit metrics remained strong for the year ended 2014. The Fitch-calculated debt/EBITDA, debt/proved developed reserves (PD), and debt/flowing barrel were approximately 1.1x, $5.95/boe, and $16,200, respectively. The upstream credit metrics allocate all outstanding debt to the E&P segment. Fitch expects these metrics to erode over the next few years as the impact of lower oil prices takes hold. Fitch's base case, assuming a West Texas Intermediate (WTI) price of $50, forecasts debt/EBITDA of less than 2.1x in 2015. However, these remain consistent with or better than similarly rated North American (N.A.) E&P peers.

SHIFTING FROM GROWTH TO RETURNS IN WEAK PRICE ENVIRONMENT

Unit, consistent with other N.A. independent E&P peers, has shifted its focus from production growth to improving efficiencies and maintaining activity at its most promising, higher return acreage in its Wilcox and Southern Oklahoma Hoxbar Oil Trend (SOHOT) plays. The E&P capital program has been scaled back 60% year-over-year with management expecting the number of wells participated in to reduce to 70 (gross) using two to four rigs from 186 (gross; 121 net) using an average of 12.2 rigs in 2014. Production is anticipated to grow 2%-4% with the liquids mix continuing to improve in 2015 benefiting from completion activity.

DOWNCYCLE HEIGHTENS RIG OBSOLESCENCE RISK

The company has been 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 in the 1,500hp range. Management seems to have recognized that the downcycle has heighten obsolescence risk for certain rigs and proactively removed 31 older, non-core rigs from service with most anticipated to be sold for parts. The new BOSS drilling rig is designed for efficient horizontal/directional drilling and has had favorable operating results, but the downcycle is likely to be a newbuild headwind. Unit has major components ordered for three additional BOSS rigs but plans to delay construction, as well as associated capital spending, until the market improves and contracts are secured.

LEVERAGE LEVEL HELPS MODERATE CREDIT RISKS

Management's current leverage levels, in conjunction with its sizing of the capital budget to be substantially in line with anticipated cash flows, provide sufficient financial flexibility to manage near-term credit risks. Fitch's base case, assuming a WTI price of $50, projects that Unit will be about $90 million free cash flow (FCF) negative in 2015 with the shortfall funded with credit facility borrowings. The Fitch base case results in debt/EBITDA under 2.1x in 2015. Debt/PD and debt per flowing barrel metrics are forecast to increase to approximately $6.45/boe, subject to any revisions, and $17,450, respectively. Fitch's base case WTI price forecast assumption of $60 in 2016 and $75 long-term suggests that the company may selectively increase drilling activity in 2016. The Fitch base case considers that the company will outspend operating cash flow generally consistent with historical levels in 2016 given supportive pricing signals resulting in a debt/EBITDA of 1.8x.

Unit utilizes a combination of swap and collared hedges to manage cash flows and support development funding. As of Dec. 31, 2014, the company's 2015 oil and gas hedges accounted for less than 10% and 45%, respectively, of its 2014 production.

ADEQUATE LIQUIDITY POSITION

UNT has historically maintained a nominal cash balance and had approximately $1 million of cash-on-hand as of Dec. 31, 2014. The company's primary source of liquidity is its $500 million senior unsecured credit facility ($334 million available capacity at year-end 2014) due Sept. 2016. The capacity of the revolver may be increased or decreased subject to the company's borrowing base ($900 million as of Dec. 31, 2014). The borrowing base is re-determined semi-annually based on the present value of oil and gas reserves and midstream cash flows with the next redetermination date scheduled for April 1st. Fitch believes that the difference ($400 million; about 45%) in the current borrowing base and elected commitment under the credit facility helps mitigate near-term redetermination-related liquidity concerns.

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 (springing covenant of EBITDA/interest above 2.25x, subject to an investment-grade rating of the notes by any one rating agency) and lien limitations, transaction restrictions, and change in control provisions. As of Dec. 31, 2014, Unit was in compliance with all of its covenants.

LIMITED OTHER LIABILITIES

Unit does not have a defined benefit pension plan. Asset retirement obligations (AROs) were $101 million, as of Dec. 31, 2014, which is lower than the $134 million reported at year-end 2013. This is mainly due to a favorable 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.

KEY ASSUMPTIONS

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

--WTI oil that trends up from $50/barrel in 2015 to $60/barrel in 2016 and a long-term price of $75/barrel;

--Henry Hub gas that trends up from $3.00/mcf in 2015 to $3.25/mcf in 2016 and a long-term price of $4.50/mcf;

--Production growth of about 3% in 2015 with increased, market price-driven activity providing mid-single digit growth in 2016 with a more robust growth profile thereafter;

--Liquids mix improves from 46% in 2014 to 47% in 2015 followed by incremental improvements thereafter;

--Drilling segment EBITDA is forecast to decline by over 50% in 2015 due to lower U.S. onshore activity with some BOSS rig newbuild offset;

--Midstream EBITDA shows more resiliency through downturn, but volumetric and commodity pricing exposure pressures margins;

--Capital spending is forecast to be $477 million in 2015, consistent with guidance, followed by an operating cash flow outspend generally consistent with historical levels given supportive pricing signals;

--No asset divestiture proceeds are forecast given the challenged onshore drilling conditions - the focus of Unit's 'non-core' assets.

RATING SENSITIVITIES

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 with some combination of the following metrics;

--Mid-cycle debt/EBITDA below 1.25x on a sustained basis;

--Mid-cycle debt/PD of $6.00-$6.50/boe and/or debt/flowing barrel below $15,000 on a sustained basis;

--Favorable oil & gas services outlook and heightened rig utilization and day rates signaling an improvement in asset quality and mix.

Future positive rating actions are unlikely without a material increase to the company's reserve base and production profile, in conjunction with strong leverage metrics. Fitch does not anticipate E&P operations to grow sufficiently over the near term to help facilitate a positive rating action given the current weak pricing environment.

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

--Mid-cycle debt/EBITDA above 1.75x-2.0x on a sustained basis;

--Mid-cycle debt/PD of $7.00-$7.50/boe and/or debt/flowing barrel approaching $20,000 on a sustained basis;

--A persistently weak oil & gas pricing environment without a corresponding reduction to capex;

--Prolonged period of weak rig dayrates and/or depressed activity levels that suggest a unfavorable oil & gas services outlook and asset quality and mix;

--Acquisitions and/or shareholder-friendly actions inconsistent with the expected cash flow and leverage profile.

Future negative rating actions remain a possibility and will be closely linked to the company's ability to retain financial flexibility through the downcycle. Fitch understands, however, that the company's midstream assets, if sold or dropped down into an MLP, could generate considerable liquidity. These types of asset sales due to their valuation resiliency and marketability have been executed by peers to improve financial flexibility. While a midstream asset sale is not contemplated in the rating, Fitch recognizes that embedded liquidity option value is present.

Fitch has affirmed the following ratings and assigned Recovery Ratings as follows:

--Long-term Issuer Default Rating at 'BB';

--Bank revolver at 'BB/RR4';

--Senior subordinated notes at 'BB-/RR5'.

The Rating Outlook is Stable.

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' (May 28, 2014);

--'Fitch Oil and Gas Assumptions Summary Feb. 2015' (Feb. 11, 2015);

--'Full Cycle Costs Drop for North American E&Ps (Efficiency Gains Show Up in 2014 Numbers)' (March 24, 2015);

--'U.S. Rig Counts Under Pressure (Downcycle to Fewer than 1,000 Rigs Followed by Longer, Slower Recovery)' (Feb. 5, 2015);

--'Shale and North American Energy (European Investor Tour)' (Oct. 23, 2014);

--'North American Energy Outlook and LNG' (July 16, 2014);

--'North American Exploration and Production Handbook' (July 16, 2014);

--'Global Impact of US Shale Oil - Rising Production Tempers World Prices' (Feb. 10, 2014);

--'Cash Flow Trends in the U.S. Energy Sector-Shareholder Activism Having an Impact' (Feb. 4, 2014);

--'Scenario Analysis: Lifting the U.S. Crude Export Ban' (Jan. 27, 2014).

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=982015

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Fitch Ratings
Primary Analyst
Dino Kritikos
Director
+1 312-368-3150
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Mark C. Sadeghian, CFA
Senior Director
+1 312-368-2090
or
Committee Chairperson
Steven Marks
Managing Director
+1 212-908-9161
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com


Source: Business Wire (March 27, 2015 - 9:17 AM EDT)

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