Fitch Downgrades Unit Corp's IDR to 'B+'; Affirms Revolver & Notes; Outlook to Negative
Fitch Ratings has downgraded Unit Corporation's (Unit; NYSE: UNT)
Long-term Issuer Default Rating (IDR) to 'B+' from 'BB'. The Rating
Outlook has been revised to Negative. Fitch has also affirmed the
ratings for Unit's senior unsecured bank revolver and senior
subordinated notes. A full list of rating actions follows at the end of
this release.
The downgrade reflects Fitch's downward revision of its energy price
deck on February 24 and its potential impact on Unit's liquidity profile
and forecasted credit metrics. Another consideration is the company's
declining size, scale and diversification, as well as the potential for
a material loss of operational momentum given the 73% reduction to
capital spending.
The Negative Outlook reflects the risks to the company's liquidity with
the possibility of commitment reductions following the April
redetermination as well as Fitch's forecasted leverage covenant
violation in 2016. This may require Unit to enter into accommodative
terms with its banking group to preserve liquidity.
Approximately $928 million of debt is affected by today's rating action.
KEY RATING DRIVERS
LOSS OF REVENUE DIVERSIFICATION
Unit has historically benefited from a modestly diversified business mix
with approximately 30% of EBITDA coming from non-exploration and
production (E&P) segments. Fitch expects the contract drilling segment
and the midstream segment to contribute approximately 20% of a lower
year-over-year EBITDA in 2016. Due to heightened recontracting risk and
further rig fleet rationalization, the contract drilling segment is
expected to represent the majority of the non-E&P EBITDA loss. The
midstream segment benefits from its 68% fee based contract mix, but the
remaining portion is at risk of lower volumes in 2016.
The E&P segment (about 63% of EBITDA) reported an almost 25%
year-over-year decline in net proved reserves (1p) to 135 million
barrels of oil equivalent (MMboe; 85% developed) for the year-ended
2015. A key driver of the decline was the impact of sharply lower prices
on reserve calculations, with the largest reduction in proved
undeveloped reserves. Production increased 9% in 2015 to 54.7 thousand
boe per day (Mboepd; 45.3% liquids mix) resulting in a reserve life of
nearly 7 years.
The contract drilling segment (about 27% of EBITDA) reported a modest
increase in revenue per day to $20,950 mainly due to the placement of
higher margin, new BOSS rigs into service during the first half of 2015.
This was offset by the rapid decline in rig utilization from 63% in 2014
to 38% in 2015. At the end of 2014, Unit had 75 rigs operating and as of
February 12, 2016 that number had dropped to 20. Fitch expects further
rig rationalization to continue.
The midstream segment (about 10% of EBITDA) reported a revenue decline
of 43% year over year mostly due to lower commodity prices. NGL volumes
sold decreased as the company operated their processing facilities in
full ethane rejection mode. Offsetting these declines, the company's gas
gathering and processing volumes increased 11% and 13% over 2014,
although if oil and gas prices remain low the effect of further
reductions in drilling activity could result in lower volumes.
Credit metrics weakened for the year ended 2015. The Fitch-calculated
debt/EBITDA, debt/proved developed reserves (PD), and debt/flowing
barrel were approximately 2.3x, $8.05/boe, and $16,946, respectively.
Fitch notes that 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 continues to strain
metrics. Fitch's base case, assuming a West Texas Intermediate (WTI)
price of $35, forecasts debt/EBITDA of 4.6x in 2016.
NEAR-TERM LIQUIDITY RISKS
As of Feb. 12, 2016, UNT had $262.9 million outstanding under their
credit agreement, down slightly from the $281 million outstanding at
year end. The company sold approximately $37.4 million of non-core oil
and gas properties since year end and has used the proceeds to pay down
the borrowings under the credit agreement. The credit facility is
unsecured but is subject to a redetermination every April 1 and October
1 based on the value of the oil and gas properties and the midstream
cash flows. In the October 2015 redetermination, the credit facility
commitment was reduced from $725 million to $550 million. Fitch believes
that management recognizes this as an issue and has matched capital
spending to stay within cash flows, considering strip prices, and
reduced outstanding revolver borrowings. Fitch's base case forecasts
leverage of 4.6x in 2016 which is greater than the credit agreement's
leverage ratio covenant of less than 4.0x (Actual of 2.58x at YE 2015).
Fitch expects Unit to receive covenant relief as part of their
semi-annual redetermination.
FORECASTED LEVERAGE METRICS WIDEN
Management's current leverage levels, in conjunction with the downsizing
of the capital budget to be substantially in line with anticipated cash
flows, reduce the need for additional debt. Fitch's base case, assuming
a WTI price of $35, projects that Unit will be free cash flow (FCF)
neutral. The Fitch base case results in debt/EBITDA of 4.6x in 2016.
Debt/PD and debt per flowing barrel metrics are forecast to increase to
approximately $8.53/boe, subject to any revisions, and $19,048,
respectively. Fitch's base case WTI price forecast assumption of $45 in
2017 and $65 long-term suggests that the company may selectively
increase drilling activity in 2017. In 2017, the Fitch base case
considers that the company may be free cash flow positive given
supportive pricing signals resulting in a debt/EBITDA of 3.6x.
HEDGES FORECAST TO PROVIDE SOME CASH FLOW UPLIFT
Unit utilizes a combination of swap and collared hedges to manage cash
flows and support development funding. As of Feb. 12, 2016, the
company's 2016 oil and gas hedges accounted for around 33% and 64%,
respectively, of its estimated 2016 production. Hedges are estimated to
provide about $22 million in additional uplift in 2016 but hedge
coverage rolls off substantially in 2017.
LIMITED OTHER LIABILITIES
Unit does not have a defined benefit pension plan. Asset retirement
obligations (AROs) were $98 million, as of Dec. 31, 2015, which is lower
than the $101 million reported at year-end 2014. 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
--WTI oil that trends up from $35/barrel in 2016 to $45/barrel in 2017
and a long-term price of $65/barrel;
--Henry Hub gas that trends up from $2.25/mcf in 2016 to $2.50/mcf in
2017 and a long-term price of $3.25/mcf;
--Production decline of about 14% in 2016 with a 6% and 3% decline in
2017 and 2018, respectively;
--Drilling segment EBITDA is forecast to decline by over 90% in 2016 due
to lower U.S. onshore activity with some BOSS rig margin offset;
--Midstream EBITDA shows more resiliency through downturn, but
volumetric and commodity pricing exposure will pressure margins;
--Capital spending is forecast to be $153 million in 2016, consistent
with guidance, followed by an operating cash flow outspend generally
consistent with historical levels given supportive pricing signals;
--No additional asset divestiture proceeds are forecast given the
challenged onshore drilling conditions
RATING SENSITIVITIES
Positive to 'BB-': 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 3.0x on a sustained basis;
--Mid-cycle debt/PD of $12.00/boe and/or debt/flowing barrel below
$18,000 on a sustained basis;
--Favorable oil & gas services outlook and heightened rig utilization
and day rates signal 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 improved leverage metrics. Management's budget suggests that the
E&P operations will struggle to grow sufficiently over the near-term to
help facilitate a positive rating action given the current weak pricing
environment. Without an improvement in business diversification,
production would need to trend towards 75 mboepd before a positive
rating action.
The Negative Outlook could be removed if the company is able to preserve
liquidity or enter into accommodative terms under their existing credit
facility following the April redetermination.
Negative to 'B': Future developments that may, individually or
collectively, lead to a negative rating action include:
--Mid-cycle debt/EBITDA above 4.5x - 5.0x on a sustained basis;
--Mid-cycle debt/PD of $14.00/boe and/or debt/flowing barrel approaching
$22,500 on a sustained basis;
--Reduction in size, scale and diversification or loss of operational
momentum in key plays;
--Material reduction in available liquidity.
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, could generate considerable liquidity. These types of
asset sales due 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.
FULL LIST OF RATING ACTIONS
Fitch has taken the following actions:
Unit Corporation
--Long-term Issuer Default Rating downgraded to 'B+' from 'BB';
--Senior unsecured bank revolver affirmed at 'BB'; Recovery Rating
revised to 'RR2' from 'RR4';
--Senior subordinated notes affirmed at 'BB-'; Recovery Rating revised
to 'RR3' from 'RR5';
The senior unsecured notes and senior subordinated notes recovery rating
was revised following the completion of a bespoke recovery analysis for
issuers with a long-term IDR in the 'B' category, consistent with
Fitch's 'Recovery Ratings and Notching Criteria for Non-Financial
Corporate Issuers.'
The Rating Outlook was revised to Negative from Stable.
Date of Relevant Rating Committee: 16 March 2016
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
Recovery Ratings and Notching Criteria for Non-Financial Corporate
Issuers (pub. 07 Dec 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=873504
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1001031
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1001031
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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