Fitch Ratings has assigned a long-term Issuer Default Rating (IDR) of
'BBB-' to Encana Corp. (NYSE: ECA). Fitch has also assigned ECA a
short-term IDR of 'F3'.
The Rating Outlook is Negative.
Approximately $5.4 billion in debt is affected by today's rating action.
A full list of rating actions follows at the end of this release.
Ratings for Encana consider the company's moderate asset scale and
production volumes, gas-weighted production profile, and numerous
actions the company has taken to improve the credit profile and bolster
overall liquidity. These include issuing approximately $1 billion in
equity in 2015 that went directly to reduce gross debt with a focus on
near-term maturities, approximately $10 billion in completed asset sales
since 2013 leading to a more focused asset base, and improvements in the
operating cost structure. The rating also reflects below-average
full-cycle economics, a reduced asset and production base post asset
sales, and the potential for a loss of operational momentum linked to
capex cuts. Despite some concerns around the core asset base quality,
runway, and execution of the long-term asset strategy, the company's
resulting profile and corporate actions to defend credit quality are in
line with an investment grade profile. Fitch expects lower production
volumes and EBITDA in 2016. However, liquidity remains adequate in
Fitch's base case and near-term maturities are not an issue, providing
additional time to implement cost structure improvements and
liquidity-enhancing measures.
The Negative Outlook is driven primarily by execution risks related the
size and timing of potential asset sales, as well as concerns about the
longer-term impact that capex cuts and non-core asset sales may have on
the company's profile.
KEY RATING DRIVERS
Moderate Asset Scale and Production Volume
ECA has moderate asset scale, with four primary positions; the Permian,
Eagle Ford (U.S.), Duvernay, and Montney (Canada). In the fourth quarter
of 2015, total production averaged 406.8 mboe/d, with these four
strategic assets contributing approximately 274.4 mboe/d (67%). ECA
expects to focus its reduced 2016 capital budget on these four strategic
assets. Fitch generally views the transition to focus on core assets
favorably, as Fitch tends to prefer scale within positions rather than
companies who are spread too thin, particularly when capital budgets are
flexed down. Fitch thinks that the company's current positions provide
decent near-term runway, particularly given lower anticipated activity
levels in 2016 and 2017.
Fitch expects production volumes to decrease in 2016 and 2017 based on
significantly lower capex combined with the effect of asset
divestitures. Lower capex will help support ECA's liquidity in the short
run as the company manages towards cash flow neutrality, but in a
sustained commodity price downturn the company may have trouble
maintaining operational momentum in its core positions.
Natural Gas Weighted with Growing Liquids Production
In 2015 production was 33% liquids (crude oil and natural gas liquids).
In the past ECA has been highly gas-weighted but has shifted towards
liquids in pursuit of higher margin production. The utility of this
shift has been reduced in the short run by declining oil and NGL prices,
but a more balanced production profile is a credit positive as the
company doesn't have overwhelming production leverage to the price of a
single commodity, providing a diversification benefit.
Numerous Actions Completed to Strengthen Balance Sheet
ECA has pursued an aggressive policy of asset sales and debt reduction
to defend an investment grade credit profile. Since 2013 approximately
$10 billion in completed asset sales have helped to prune the overall
asset base, create better operational focus, fund reduction to gross
debt, as well as the entry into the Permian and Eagle Ford via
acquisitions. The company expects to close a $900 million sale of DJ
Basin assets in Q2 2016. ECA has cut the dividend two times to preserve
liquidity, most recently to $51 million per year, down from as much as
$558 million in 2012. The company has also reduced capex significantly,
cutting 2016E capex to $1 billion from $2.5 billion in 2014 and $2.2
billion in 2015.
Collectively, these actions serve as a material support for the credit
as it better aligns the company's capital structure with a reduced asset
base and should allow the company to better weather commodity price
volatility. Fitch expects that ECA will continue to pursue monetizations
of non-core assets in order to strengthen the balance sheet and enhance
liquidity.
Subpar Historical Reserve Replacement
Three-year average organic replacement was -4% and 24% in 2014 and 2015,
respectively, driven by substantial price-related revisions, asset
repositioning, and limited additions from extensions and development
activity relative to spending levels. Three-year average FD&A was
$49/boe in 2015, driven higher by the 2014 acquisitions and price
revisions. Reserve replacement will be an area of focus as Fitch
monitors management's operational execution and ECA credit quality.
Hedge Protection Falling Off in 2017
Based on hedge positions as of Feb 26, 2016, ECA has approximately 75%
2016 (March to December) oil & gas volumes hedged. Fitch estimates total
cash hedging receipts of $528 million in 2016, falling off sharply in
2017. ECA has a portion of gas production hedged for 2017, but these
provide minimal cash flow support at Fitch's base case. However, they
would provide moderate cash flow support in a stress case scenario.
Fitch anticipates that ECA will continue to hedge production volumes
consistent with its historical hedging policies. However, Fitch does not
assume prospective hedging volumes or swap/collar prices in forecasting
future cash flows and subsequent credit metrics.
Recent Financial Performance
As calculated by Fitch, ECA's 2015 year end debt/EBITDA rose to 2.1x
versus 1.8x in 2014. This was offset by a 36% decline in EBITDA due to
lower price realizations and lower production volumes related to asset
sales. The company has been proactive in reducing debt with gross debt
decreasing by approximately $2 billion in 2015, which has helped to
support credit metrics. Fitch expects ECA to be moderately FCF negative
in 2016 and 2017 but believes this should be manageable given ECA's
current liquidity position and potential for additional non-core asset
sales.
As calculated by Fitch, ECA's cash netbacks after hedges were $14.7 per
BOE in 2015, moderately lower than the $15.5 received in 2014. Debt to
1P rose to 6.7x in 2015, primarily due to the effect of lower LTM
pricing on reserve calculations. Encana's 2015 debt/flowing barrel of
$13,181/boe compares favorably amongst investment grade E&P peers.
However, further material declines in production volumes, either through
asset sales or natural declines not offset by new production, could
create stress in credit metrics if not offset by lower levels of gross
debt.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Encana include:
--Base case WTI oil price that trends up from $35/barrel in 2016 to a
long-term price of $65/barrel;
--Base case Henry Hub gas that trends up from $2.25/mcf in 2016 to a
long-term price of $3.25/mcf;
--Total 2016 production of 350 mboe/d;
--Capex of $1 billion in 2016;
--Hedge positions as of Feb 26, 2016 are applied the cash flow model,
with estimated 2016 proceeds of $528 million in Fitch's base case;
--Additional non-core asset sales are pursued.
RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively,
lead to a negative rating action include:
--Inability to reduce gross leverage through asset sale proceeds or
other creditor-friendly measures
--Mid-cycle Debt/EBITDA above 3.0x
--Mid-cycle debt/flowing above $16,500
--Poor organic reserve replacement, negative cash netbacks, and/or
uneconomic capex deployment
Continued operating cost improvements, prudent capital deployment, and
continued aggressive protection of the rating through asset sales and/or
equity issuance may be required to weather a sustained downturn in oil &
natural gas prices at an investment-grade rating.
To remove the Negative Outlook at 'BBB-':
--Successful completion of non-core asset sales with proceeds used to
reduce gross debt
--Mid-cycle Debt/EBITDA below 3.0x
For an upgrade to 'BBB' (individually or collectively)
--Total company production approaching 500 mboe/d
--Evidence of sufficient runway in core positions to support credit
quality and scale consistent with 'BBB' peers
--Mid-cycle Debt/EBITDA below 2.5x
--Mid-Cycle Debt/Flowing Barrel below $14,000/boe
--Improved full-cycle economics via economic reserve additions and
operating cost improvements
Upgrades to 'BBB' are not considered probable over the rating horizon.
Adequate Liquidity at YE15, No Near-Term Maturities
At YE15, ECA had $4.2 billion of liquidity, consisting of $3.9 billion
undrawn on unsecured revolving credit facilities and cash on hand of
$271 million. The facilities remain committed through July 2020. When
combined with asset sales of $900 million to be received in Q2 2016,
Fitch expects that near-term liquidity will be more than adequate to
fund the company's reduced capex budget. ECA has been proactive about
reducing debt with a focus on near term maturities. As of YE15, the next
maturities include $500 million due 2019 and $600 million due 2021.
Fitch expects adequate liquidity, as asset sale proceeds should reduce
outstanding draw on the credit facilities, and the reduced capex budget
will likely be scaled close to operating cash flow, including hedge
proceeds. Fitch's base case expects that available liquidity will remain
above $4 billion, and the company has limited near-term maturities that
could create calls on liquidity. A significant portion of ECA capex is
discretionary, so the company retains significant flexibility in lower
for longer price environment. However, this would have knock on effects
on production volumes and operational momentum that could prompt rating
changes despite sufficient liquidity.
FULL LIST OF RATING ACTIONS
Fitch has assigned the following ratings:
Encana Corp.
--Long-term IDR 'BBB-';
--Senior unsecured notes 'BBB-';
--Senior unsecured credit facility 'BBB-';
--Short-term IDR 'F3';
--Commercial paper 'F3'.
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
Additional Disclosures
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1000914
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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