-- 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.
On Nov. 13, 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
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 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
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.
The 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 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.
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
New Rating; CreditWatch/Outlook Action
Rex Energy Corp.
Corporate Credit Rating B/Stable/--
Rex Energy Corp.
US$250 mil sr unsecd nts due B-
Recovery Rating 5