TEXT - S&P cuts Goodrich Petroleum rating to 'B-'
Overview -- U.S.-based Goodrich Petroleum Corp.'s liquidity has deteriorated as a result of a borrowing base reduction and lower-than-anticipated oil production. -- We are lowering our corporate credit rating to 'B-' from 'B', and lowering the issue rating on Goodrich's senior unsecured debt to 'CCC' from 'CCC+'. -- The stable outlook reflects our expectations that the company should be able to raise capital to fund ongoing drilling expenditures and the potential repurchase of its convertible notes, which become putable in 2014. Rating Action On Nov. 13, 2012, Standard & Poor's Ratings Services lowered its corporate credit rating on Houston-based Goodrich Petroleum Corp. (GDP) to 'B-' from 'B'. The outlook is stable. We also lowered our issue-level rating on the company's senior unsecured debt to 'CCC' from 'CCC+'. The recovery rating remains '6', indicating our expectation of negligible (0% to 10%) recovery to creditors in the event of a payment default. Rationale Our rating action reflects a reduction in the company's borrowing base as well as third-quarter oil production coming in slightly below expectations, resulting in the company reducing its 2012 oil production exit rate guidance by 10%. The production shortfall was a result of asset sales and delayed completions in the Tuscaloosa Marine Shale oil play. We believe the company's liquidity is "less than adequate" and will decline to $95 million by year-end 2012 and to $20 million by year-end 2013 (based on the Standard & Poor's price deck and our capital spending assumption of $200 million next year). In our view, this level of liquidity plus anticipated operating cash flows will not be sufficient to cover the company's capital expenditures and the potential repurchase of its convertible notes maturing in 2029, which become putable at the option of the holders on Oct. 1, 2014. The ratings on GDP reflect our assessment of the company's "vulnerable" business risk, "highly leveraged" financial risk, and "less than adequate" liquidity. The ratings incorporate GDP's participation in the highly cyclical, capital-intensive and competitive oil and natural gas exploration and production (E&P) industry, its relatively small and geographically concentrated reserve base, its meaningful exposure to weak natural gas prices in 2013, and our projection that the company will generate negative free operating cash flow (FOCF) in 2012 and 2013. Our ratings on GDP also reflect the company's ongoing shift to oil development in the Eagle Ford and Tuscaloosa Marine shales, and management's track record of raising external capital. We view GDP's business risk profile as "vulnerable" given its small size, high proportion of natural gas reserves, and high proportion of proved undeveloped (PUD) reserves that require significant spending to bring to production. GDP's proven reserve base at year-end 2011 was a relatively small 500 billion cubic feet equivalent (bcfe), 92% natural gas and 58% proved undeveloped. The company has meaningful exposure to the dry gas Haynesville shale, which accounts for nearly two-thirds of GDP's proven reserve base and 50% of its current production, and where unhedged returns are marginal at current natural gas prices. Importantly, given the pricing discrepancy between oil and natural gas, GDP has allocated most of its 2012 capital to develop oil projects in the Eagle Ford shale in South Texas, where it holds 40,000 net acres, and the Tuscaloosa Marine shale (TMS) in Louisiana/Mississippi, where it holds 132,000 net acres. The company has set its 2012 capital budget at $250 million: nearly two-thirds of which has been allocated to the Eagle Ford, about 16% to the TMS, and just 9% to the Haynesville (primarily to meet drilling commitments under lease terms). The remaining 11% has been allocated to leasehold and infrastructure. Although the company has not yet given formal guidance for 2013 capex, we are assuming GDP will spend about $200 million, with the majority allocated to the Eagle Ford and TMS. There is still limited industry data on the emerging TMS play, and thus it carries higher execution risk. As a result of this capital allocation, as well as recent asset sales, overall production will decline this year, but will become more oil-weighted resulting in higher unhedged price realizations and margins. In the third quarter of 2012, production averaged 84 million cubic feet equivalent per day (mmcfe/d), which was down 27% versus the year-ago quarter. However, volumes constituted 23% oil, up from just 11% in the third quarter last year. For full-year 2012, we expect total production to decline by 20%, with oil production up 75% and natural gas volumes down 30%. In 2013, we project production to decline by 0% to 5%, with oil volumes up about 60% and natural gas volumes down 20%. By the end of next year, GDP's production should be nearly 40% oil, which should improve the company's overall profitability based on our current pricing assumptions. We view GDP's financial risk as aggressive, reflecting its small size, our estimate that the company will outspend FFO in 2012 and 2013, and tightening liquidity next year. Based on our price deck of $2.50 per mmBTU natural gas and $85 per barrel of oil for the remainder of 2012, and $3.00 per mmBTU and $80 per bbl in 2013, along with a capital budget of $250 million in 2012 and $200 million in 2013, we project GDP will generate EBITDA of $185 million in 2012 and $160 million next year. The drop in 2013 is primarily due to the roll-off of the company's hedges, offset by the increase in oil volumes. GDP has nearly 90% of this year's natural gas and oil production hedged at above-market prices, but has no gas hedges and just 30% of its oil hedged for 2013. Consequently, we are projecting debt/EBITDA to reach 3.7x by the end of 2012 and increase to 4.7x by the end of 2013. Liquidity We classify GDP's liquidity as "less than adequate." Key elements of GDP's liquidity profile include: -- As of Sept. 30, 2012, Goodrich had about $1.5 million in cash and $111 million available under its $210 million borrowing base (which was reduced from $265 million in October 2012). -- Over the next three quarters, we expect the company to remain in compliance with the facility's financial covenants, which require GDP to maintain an interest coverage ratio above 2.5x and a debt to EBITDAX ratio below 4.0x (unlike Standard & Poor's debt estimate, GDP's debt calculation per the covenant does not include the $70 million in adjustments for operating leases, asset retirement obligations, and preferred stock). -- However, without raising capital or significantly reducing capital expenditures, we estimate GDP could breach its debt to EBITDAX covenant at year-end 2013. -- Based on our commodity price assumptions, and assuming capital expenditures of $250 million in 2012 and $200 million in 2013, we estimate that the company will outspend funds from operations (FFO) by about $108 million in 2012 and $80 million in 2013. -- The 2012 spending gap was primarily funded by asset sales ($95 million closed year-to-date), and we estimate further asset sales, joint ventures, or equity/debt raises will be necessary to fund next year's capital expenditures and fund the potential repurchase of its convertible notes in 2014. -- The company has no near-term debt maturities, although its $218 million convertible notes due 2029 are putable to the company (at the option of holders) on Oct. 1, 2014. -- We expect that sources of liquidity will exceed uses by 1.4x in 2012 and by 1.1x in 2013 (excluding any external capital), which is slightly below the level required for "adequate" liquidity under our criteria. -- We estimate the company could reduce spending to maintenance capital expenditures (i.e., the level of spending required to keep production flat) of about $150 million, although reining in spending to this level would likely result in significantly lower oil production and FFO. Recovery analysis The rating on GDP's unsecured debt is 'CCC' (two notches below the corporate credit rating), and the recovery rating is '6', indicating our expectation that lenders would receive negligible (0% to 10%) recovery in the event of a payment default. Standard & Poor's analytical approach towards determining recovery on debt has three basic components: 1) determining the most likely path to default, 2) estimating the value of a company following default, and 3) distributing that value to estimated claimants based on relative priorities. Our simulated default scenario for GDP contemplates a default in 2014, stemming from a sustained period of low commodity prices. We also assume that claims on the revolver (approximately $185 million) are capped at 85% of our estimated reserve value for the company and $510 million claims on the senior unsecured debt include six months of pre-petition interest. Our $215 million valuation of GDP's reserves is based on a company-provided PV10 report computed using our recovery price deck assumptions of $50 per barrel for West Texas Intermediate crude oil and $3.50/mmBTU for Henry Hub natural gas. We expect that a majority of this value would be used to service assumed bankruptcy enforcement costs of $10 million and the claims on the secured revolver, leaving $20 million to services the senior unsecured debt. Thus, we have assigned a recovery rating of '6' to the senior unsecured notes, indicating our expectations of negligible (0% to 10%) recovery on the company's senior unsecured notes. Outlook The stable outlook reflects our expectation that GDP should be able to raise capital, either via asset sales, entering into a joint venture, or issuing equity or debt, in order to fund ongoing drilling expenditures and the potential repurchase of its convertible notes in 2014. We could lower the rating if it appears GDP is unable to execute planned asset sales or joint ventures, or is unable to access the capital markets within the next six to nine months. We could raise the rating if GDP is successful in improving its liquidity position without increasing leverage above the 4.75x area. Related Criteria And Research -- Revised Assumptions For Assigning Recovery Ratings To The Debt Of Oil And Gas Exploration And Production Companies," Sept. 14, 2012 -- Standard & Poor's Raises Its U.S. Natural Gas Price Assumptions; Oil Price Assumptions Are Unchanged, July 24, 2012. -- Key Credit Factors: Global Criteria For Rating The Oil And Gas Exploration And Production Industry, Jan. 20, 2012. -- Methodology And Assumptions: Standard & Poor's Standardizes Liquidity Descriptors For Global Corporate Issuers, July 2, 2010. Ratings List Downgraded To From Goodrich Petroleum Corp. Corporate Credit Rating B-/Stable/-- B/Stable/-- Goodrich Petroleum Corp. Senior Unsecured CCC CCC+ Recovery Rating 6 6
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