TEXT-S&P assigns Rex Energy 'B' rating
Overview -- We have assigned our 'B' corporate credit rating to U.S.-based Rex Energy Corp. -- We have assigned our 'B-' issue-level rating and '5' recovery rating to Rex's $250 million senior unsecured notes due 2020. -- The stable outlook reflects our expectation that Rex will develop its Appalachian Basin assets without weakening its credit protection measures or its adequate liquidity. Rating Action On Dec. 6, 2012, Standard & Poor's Ratings Services assigned its 'B' corporate credit rating to State College, Pa.-based Rex Energy Corp. The outlook is stable. We also assigned our 'B-' issue-level rating (one notch lower than the corporate credit rating) to Rex's planned $250 million senior unsecured notes due 2020. We assigned this debt a '5' recovery rating, indicating our expectation of modest (10% to 30%) recovery in the event of a payment default. Rex is using proceeds from the offering to pay down borrowings under its credit facility and its second-lien term loan ($122 million and $50 million, respectively, outstanding as of Sept. 30, 2012) and to fund 2013 capital expenditures. Rationale The ratings on Rex Energy Corp. (Rex) reflect our assessment of the company's "vulnerable" business risk profile and its "highly leveraged" financial risk. The ratings incorporate the company's relatively small size and scale, its limited geographic diversity, meaningful proportion of reserves and production exposed to weak natural gas prices, current lack of takeaway capacity, its relatively high cost base, a high proportion of riskier proved undeveloped reserves, and its participation in the capital-intensive and very cyclical exploration and production (E&P) industry. Ratings also reflect the company's "adequate" liquidity and its prospects for increased condensate production, especially natural gas liquids (NGLs). Standard & Poor's views Rex's business profile as vulnerable because of its relatively small proved reserve base that is weighted to weak natural gas prices. Rex's proved reserve base was 612 billion cubic feet equivalent (Bcfe) as of Oct. 31, 2012. However, approximately 351 Bcfe or 57% of these reserves are in the proved undeveloped (PUD) category and 61% of its reserve base is tied to soft natural gas. Its undeveloped reserves could be at risk for a write down if Rex pulls back on its development spending plans or if it is unable to increase its NGL production. Rex's reserve base also lacks geographic diversity. Approximately 92% of its proved reserves and 83.6% of its third-quarter production came from the Appalachian Basin, meaning its cash flows could be at risk if it encounters processing or takeaway challenges, weather disruption, or regulatory limitations on its drilling and fracking program. In the Appalachian, Rex operates in the Marcellus in Pennsylvania and the Utica in Ohio. Both of these plays are characterized by their limited processing and takeaway capacity as compared with mature basins such as the Permian. Although Rex has some long-term takeaway contracts in place, some of the infrastructure is currently in construction, meaning Rex's production could be at risk if there is a disruption in these projects. Rex's primary position in the Marcellus is in the Butler County region in western Pennsylvania, which accounts for nearly 70% of its proved reserves. Approximately 43% of reserves in Butler contain profitable NGLs, in particular propane and ethane, while the remainder is dry gas. Because of limited processing capacity in the Marcellus, Rex uses most of its ethane for fuel at its processing plant. Incoming processing capacity should allow Rex to sell its ethane by early 2014, which we think could add to profitability. Rex also has a non-operated position in Westmoreland, Clearfield, and Centre Counties in the Marcellus. This region is mostly dry gas, so we do not expect that it will contribute much to profitability or cash flows. In the Utica shale in Ohio, Rex has 15,500 net acres in the Warrior North Prospect in Carroll County and 4,000 net acres in the Warrior South in Guernsey, Noble, and Belmont counties. Development of the Utica is still in its infancy, and the industry does not have much production history in the play. Preliminary drilling results have been promising, with solid production rates and good liquid content. However, there have been only a small number of wells drilled and many of the results are based on peak rates. As a result, future production rates and the percentage of liquids are uncertain. Rex also has a position in the Illinois Basin, which is a very mature oil-weighted play that represents approximately 8% of reserves. We expect that Rex will use a combination of conventional drilling, recompletion, and enhanced oil recovery to maximize its production of profitable crude oil. Given the Illinois Basin's minimal production contribution and its limited growth prospects, we do not expect it to contribute meaningfully to Rex's profitability or credit protection measures going forward. Rex's cash cost structure is slightly higher than Marcellus-based peers such as Range Resources, EQT, and Penn Virginia, given the company's relatively smaller size and fewer operating efficiencies, especially with regards to personnel and equipment. However, as the company expands its production base, costs and efficiencies could improve. Cash costs (inclusive of lease operating expense, production tax, and cash general and administrative expense) in the third quarter of 2012 were nearly $2.80/Mcfe as compared with rated Marcellus peers that are typically under $2/Mcfe. The company's three-year finding and development (F&D) costs at $1.31/Mcf (excluding price revisions) are competitive. Looking forward, we expect that F&D costs will remain favorable given the likelihood that its NGL-directed drilling program should yield some condensate reserve additions. We view Rex's financial risk profile as highly leveraged, reflecting its adequate liquidity, moderate debt leverage and our expectation that it will outspend funds from operations (FFO) in 2013 and 2014. Pro forma for the $250 million offering and inclusive of asset retirement obligations (AROs) and operating leases, debt was nearly $270 million on Sept. 30, 2012. Under our current operating assumptions, we forecast that EBITDA in 2013 and 2014 will total nearly $130 million and $170 million, respectively, resulting in leverage of approximately 3x over the next two years. After interest and cash taxes, we project FFO of about $90 million next year and $120 million in 2014. Assuming a capital spending program near $260 million annually, we think that Rex will outspend cash flows by $180 million next year and $150 million in 2014. We assume that the company will use its credit facility to fund this outspending. Given the projected cash flow shortfalls, Rex could need to cut its spending program if it cannot raise capital, which would weaken production and therefore profitability. Our projections incorporate the following expectations and assumptions: -- We use a price assumption for natural gas of $2.50/Mcf for the remainder of 2012, $3/Mcf in 2013, and $3.50/Mcf in 2014. Our assumption for West Texas Intermediate (WTI) crude oil is $85 per barrel (bbl) for the remainder of 2012, $80/bbl in 2013, and $75/bbl in 2014. We have assumed that NGLs will represent 50% of WTI in 2013 and 57% in 2014. -- We have forecast that production will average nearly 100 million cubic feet equivalent per day (MMcfe/d) in 2013 and 130 MMcfe/d in 2014. Of this production mix, we project that natural gas will constitute approximately 70% of production annually and that NGLs will constitute nearly 15% next year and 20% in 2014. -- We have incorporated Rex's hedges next year for about 54% of its production and in 2014 for about 16% of forecast production. Regarding natural gas, Rex has more than 60% of projected 2013 production hedged at an average of more than $4.30/Mcf and about 20% of forecast 2014 production hedged at approximately $3.50/Mcf. Liquidity We consider Rex's liquidity to be adequate, reflecting the following assumptions and expectations: -- Upon closing of the proposed notes issuance, Rex will have cash on hand of more than $70 million and full availability on its revolving credit facility, which will reduce to $240 million pro forma for the notes issuance. -- Over the next 12 months, we project that Rex will maintain sources of liquidity of approximately 1.2x its uses of liquidity. -- We project that the company will outspend FFO by $180 million in 2013 and $150 million in 2014. We have assumed that the company will use its borrowing base to fund this outspending. -- We think that Rex has flexibility to reduce its capital program if necessary--to approximately $50 million--and maintain flat production compared with 2012 and to $75 million without risking its leasehold requirements. -- Covenants include a maximum debt to EBITDAX ratio of 4.25x and a minimum interest coverage ratio of 3x. We do not forecast the company breaching these requirements. Recovery analysis The analytical approach toward determining recovery on debt has three basic components: determining the most likely path to default; estimating the value of a company following default; and distributing that value to estimated claimants based on relative priorities. Our simulated default scenario contemplates a default in 2015, stemming from a sustained period of low commodity prices. We also assume that claims on the revolver (approximately $235 million) are capped at 85% of our estimated reserve value for the company and the $260 million claims on the senior unsecured notes include six months of pre-petition interest. Our $280 million valuation of Rex's reserves is based upon a company-provided PV10 report computed using Standard & Poor's recovery price deck assumptions of $50 per barrel for West Texas Intermediate crude oil and $3.50 per million Btu for Henry Hub natural gas. We expect that a majority of this value would be used to service assumed bankruptcy enforcement costs of $15 million and the claims on the secured revolver, leaving $30 million to service the claims on the notes. Thus, we have assigned a recovery rating of '5' to the senior unsecured notes, indicating our expectations of modest (low end of the 10% to 30% range) recovery on the notes in a default scenario. Outlook The stable outlook reflects our expectation that Rex will successfully develop its asset base in the Appalachian Basin. We expect that the company will maintain leverage near 3x and adequate liquidity for the next several years. An upgrade will require the development of its NGL and crude oil acreage. We could downgrade the company if we expect run rate leverage to exceed 4.75x, which could occur if Rex does not realize its production targets. Related Criteria And Research -- 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 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List New Ratings; Outlook Action Rex Energy Corp. Corporate Credit Rating B/Stable/-- Senior Unsecured Local Currency B- Recovery Rating 5 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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