TEXT - S&P raises Halcon Resources rating to 'B'
Overview -- U.S. oil and gas exploration and production company Halcon Resources Corp. has completed its transaction to acquire oil and gas producing properties in the Williston Basin in North Dakota and Montana targeting the Bakken and Three Forks formations. -- We are raising our corporate credit rating on Halcon to 'B' and removing it from CreditWatch. -- We are removing the rating from CreditWatch with positive implications. The outlook is stable. Rating Action On Dec. 7, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on Houston-based Halcon Resources Corp. to 'B' from 'B-' and removed the rating from CreditWatch positive where it was placed on Oct. 22. The outlook is stable. The 'CCC+' issue rating and '6' recovery rating on the company's $1.5 billion senior unsecured notes are unchanged. The '6' recovery rating indicates our expectation of negligible (0% to 10%) recovery for lenders in the event of a default. Rationale The upgrade follows Halcon's completed transaction to acquire Williston Basin properties from Petro-Hunt LLC and Pillar Energy LLC in a transaction with a substantial equity funding component. The transaction materially increases the company's reserves and production in properties contiguous to existing operations and lowers debt leverage on a pro forma basis. At the close of the acquisitions, Halcon has approximately 115 million barrels of oil equivalent (mmboe) of proved reserves and production of approximately 26,500 barrels of oil equivalent per day (boe/d), which supports the current rating. Oil and natural gas liquids account for 79% of reserves and 49% are characterized as proved-developed, the lowest-risk category. We view both a high liquids proportion and high proved-developed percentage relatively favorably, although proved-undeveloped reserves can provide opportunities for growth. Historical operating costs (lease operating expense, production taxes, and general and administrative costs) are high at about $26 per boe reflecting the mature nature of a substantial portion of Halcon's producing assets, which require artificial lift to produce. We expect costs to improve to below $20 per boe as Halcon adds new production, and that internal reserve replacement will be adequate as the company develops its extensive acreage holdings. Halcon derives about 65% of production from major liquids-rich resource plays that offer attractive growth prospects: the Bakken Shale in Montana and North Dakota and the Woodbine/Eagle Ford formation in Texas. Properties in the Eagle Ford formation will be divested to comply with management's non-compete agreement. The remaining portion of production comes from conventional assets located mainly in Texas, Louisiana, and Oklahoma. We expect the company to focus on optimizing production and reducing costs at these relatively mature properties. Halcon holds leases for more than 700,000 net acres, including more prospective areas including the Wilcox, Mississippi Lime, and Utica Shale formations as well as areas where it has existing proved reserves and production. Concerns about the level and source of capital required to develop this broad collection of properties are reflected in the ratings on Halcon. Financial leverage following the acquisition and equity issued to fund a portion of the purchase price is approximately 4.7x debt to EBITDA, which we view as acceptable for a 'B' rating. We annualize pro forma EBITDA for the first half of 2012 for this calculation. We expect leverage to decline to below 4.0x debt to EBITDA in 2013 as improved cash flow, caused by higher liquids production, more than offsets higher debt. Halcon plans to hedge a significant portion of its expected production, providing a measure of cash flow protection. We estimate that the company will need $900 million of external funding (inclusive of borrowings under its credit facility) in 2013 to fund growth plans. We think Halcon will generate modest funds from operations (FFO) in 2012 at our current price deck (which for West Texas Intermediate (WTI) oil is $85 for the remainder of 2012, $80 in 2013, and $75 in 2014 and thereafter--and for natural gas is $2.50 for the remainder of 2012, $3.00 in 2013, and $3.50 in 2014 and thereafter). Cash flow will likely benefit from increased production and cost reduction in 2013, but we expect capital spending to exceed internally generated cash flow again by a wide margin. We anticipate that following the transaction Halcon has no borrowings under its $1.5 billion credit facility with an $850 million borrowing base. Liquidity We characterize Halcon's liquidity as "less than adequate". Our assessment incorporates the following expectations and assumptions: -- We project that 2012 FFO will approximate $60 million; -- The company's capital budget for the year is $1.1 billion. We expect that the 2013 budget will be meaningfully higher in the context of a larger asset base. -- The company's undrawn credit facility has an $850 million borrowing base. -- We project that Halcon will need approximately $900 million of external capital, inclusive of credit facility borrowings, to fund its spending plans in 2013, which exceeds the current borrowing base. -- We expect the company to use some combination of asset sales, equity, and debt issuance to fund its capital needs while maintaining liquidity. -- However, the execution risk associated with this assumption is a significant factor in the rating. -- We view management's track record of building E&P companies as favorable for Halcon's ability to attract funding. Recovery analysis The ratings on the company's senior unsecured notes are rated 'CCC+' (two notches below the corporate rating) and the recovery is '6', indicating our expectations of negligible (0% to 10%) recovery for bondholders in the event of a payment default. The ratings on the notes reflect the size of the borrowing base and our assessment of the company's corporate credit rating following the acquisition. For the full recovery analysis, please see the recovery report on Halcon published on RatingsDirect on Oct. 25, 2012. Outlook The stable outlook reflects our expectation that Halcon will manage its ambitious cost reduction and production growth targets while maintaining projected leverage under 5x debt to EBITDA and improving liquidity. Meeting financial goals while funding an aggressive capital spending program require that Halcon obtain significant external funding. We would consider a positive rating action if Halcon achieves its growth objectives while managing debt to EBITDA in the area of 4x or lower, improving liquidity and managing capital spending closer to internally generated cash flow. We would consider a negative rating action if the company faces material liquidity issues that limit its access to capital to fund its growth or if debt to EBITDA exceeds 5x without a clear path to improvement. 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 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Temporary contact information: Ben Tsocanos, New York (1) 212-438-5014 (203-800-5146); Christine Besset (214-765-5865) Ratings List Upgraded; Off CreditWatch; Outlook Stable To From Halcon Resources Corp. Corporate Credit Rating B/Stable/-- B-/Watch Pos/-- Ratings Affirmed Halcon Resources Corp. Senior Unsecured CCC+ Recovery Rating 6