Fitch Ratings has downgraded the long-term Issuer Default Rating (IDR) and unsecured debt ratings of Devon Energy Corp. to “BBB” from “BB+.” The company's short-term IDR and commercial paper ratings are affirmed at “F2.” The Rating Outlook for Devon is Stable. The rating actions affect approximately $10 billion in rated debt.
The downgrade results from the announcement that Devon is acquiring privately held GeoSouthern Energy's assets in the Eagle Ford oil play in South Texas for $6 billion in cash. The financing for the transaction comprises $1.5 billion of existing cash on hand and $4.5 billion of new intermediate-term debt. As a result of this announcement, Devon's net debt will effectively double and net debt to EBITDA is expected to rise from approximately 1.0x to be between 1.5x-2.0x pro forma for the transaction.
According to the ratings agency, “Notwithstanding the increase in leverage, the acquisition has several positive aspects in Fitch's view. First and foremost, the purchase price is relatively conservative at 4x next year's estimated EBITDA from the acquired assets. Secondly, it expands Devon's portfolio into a high-quality basin that mostly has high-margin crude production and should be self-funding on a go-forward basis while providing significant future volume growth. Moreover, it will allow Devon to become free cash flow neutral on corporate wide basis in the near-to-intermediate term."
The current ratings reflect Devon's position as a very large diversified exploration and production company, its low cost reserve position and production profile, its moderate leverage and conservative operational and financial strategy. Pro forma for the transaction, Devon's proven reserve base will exceed 3 billion barrels of oil equivalent (boe) and its daily production will exceed 700,000 boe/d.
Devon has indicated that it will be divesting assets it deems “non-core” in the intermediate term in an effort to optimize its portfolio. Proceeds are expected to be used to help de-lever and retire acquisition related debt over time. Fitch noted that the pace of asset sales and performance of Devon's portfolio will determine any future positive rating actions.
Liquidity is provided by cash on hand (estimated to be $2 billion-$2.5 billion pro forma), the company's $3 billion CP program and its $3 billion revolving credit facility due 2018. The credit facility contains one material financial covenant that requires the company's ratio of total funded debt to total capitalization to be less than 65%. Fitch said that, as of the end of the third quarter, the company was in compliance with this covenant with a debt to capitalization ratio of 22.4%. Near-term maturities other than its $1.6 billion commercial paper balance are $500 million in senior notes due in January of 2014 and $500 million in senior note due in July of 2016.