Fitch has upgraded Chesapeake Energy’s long-term Issuer Default Rating (IDR) and senior unsecured ratings to ‘BB’ from ‘BB-‘ and also upgraded the company’s preferred stock to ‘B+’ from ‘B-. A full list of ratings actions follows at the end of this release. The ratings actions affect approximately $14.8 billion in rated securities.
The Rating Outlook remains Positive.
Key Ratings Drivers
The upgrade results from the debt reduction and capital structure simplification that has occurred over the last few months. Notably, the company has spun-off its oil services division that resulted in debt reduction of over $1 billion and paid off the $1.06 billion in preferred interest of CHK Utica, which Fitch treated as adjusted debt.
The Positive Outlook is driven by Chesapeake management’s intention to further de-lever and simplify its capital structure and expectations of significantly reduced free cash flow deficits in the future.
Chesapeake’s ratings reflect the company’s large asset base, operating profile and levered capital structure. As of year-end 2013, the company had almost 2.7 billion in proved reserves with nearly 70% of those being proved developed.
Chesapeake has large attractive asset positions in the Marcellus and Utica Shales, the Eagle Ford Shale, various plays in the Mid-Continent region, the Haynesville shale as well as the Barnett and Niobrara Shales. Expected 2014 production of 685,000-705,000 boe per day is comprised of approximately 16% oil, 12% NGLs and 72% natural gas and makes Chesapeake the second largest natural gas producer in the U.S. and the 10th largest in terms of liquids.
The company’s levered capital structure offsets the strengths of Chesapeake’s asset base and operating profile. Balance sheet debt of $11.5 billion as of June 30, 2014 is augmented by other debt like obligations such as minority interests, other long-term liabilities, VPP adjustments, etc. that Fitch includes in its adjusted debt calculations. Pro forma for the redemption of the CHK Utica preferred interests in this quarter Fitch estimates adjusted debt is slightly over $15 billion exclusive of Chesapeake’s preferred stock of approximately $3 billion.
Liquidity is primarily provided by the company’s $4 billion corporate senior secured credit facility (due December 2015) which was undrawn at quarter end.
The corporate credit facility contains various covenants and restrictive provisions and is fully and severally guaranteed by Chesapeake and certain of its wholly owned subsidiaries. The most restrictive of these covenants state that maximum debt/EBITDA must be less than 4.0X and maximum consolidated total capitalization must be less than 70%. Chesapeake is well within these covenants.
The company’s’ near-term maturities are $396 million in 2.75% contingent convertible senior notes due 2035 that can be put or called by the company in late 2015. Maturities for 2016 include $500 million in 3.25% senior notes.
Credit metrics and expectations
Currently, Chesapeake has adjusted debt/EBITDA of approximately 3x per Fitch calculations. Remaining asset sales in 2014 are anticipated to be another $700 million in proceeds.
Additionally, further additional adjusted debt reduction is expected from the redemption of CHK Cleveland Tonkawa preferred interests. While FCF deficits have been greatly reduced from prior periods Fitch still expects the company to be FCF negative by approximately $700 million- $1 billion in 2014 inclusive of capitalized interest and distributions.
Going forward, Fitch expects that the company will fund capital spending, capitalized interest, dividends and distributions from operating cash flows.
Operationally, Chesapeake is forecasting that its production for 2014 will average between 685,000 – 705,000 boe per day, which is an absolute increase over 2013’s level of 668,483 boe per day.This continues a trend of annual production increases from Chesapeake going back years.
Currently, a little over half of Chesapeake’s production comes from the Marcellus North, the Mid-Continent region and the Eagle Ford Shale. Realizations for natural gas relative to benchmark prices for Chesapeake are challenged because of high gathering and transport costs. Over time, efficiency gains for drilling, procurement, etc. on the cost side should help to expand margins and improve capital costs on a boe basis.
The company’s three-year average finding, development and acquisition is solid with cost per Fitch’s calculations at $20.94 per boe while its three-year average organic F&D cost is $14.51 per boe. Organic reserve replacement last year was over 200% and Chesapeake’s proved reserve life is a healthy 11 years.
Positive: Future developments that may, individually or collectively lead to positive rating action include:
Reducing adjusted debt/EBITDA to approximately 2.5X or below on a sustained basis;
Continued progress in deleveraging its capital structure relative to reserves and production;
Cash flow generation leading to consistent and, at least, neutral free cash flow generation after capex, capitalized interest, dividends and distributions.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
Mid-cycle adjusted debt/EBITDA or 3.5 or greater on a sustained basis;
Negative free cash flow after capex, capitalized interest, dividends and distributions leading to rising adjusted debt levels relative to reserves and production;
Marked decrease in production levels or proved developed reserves relative to adjusted debt.
Fitch has taken the following ratings actions on Chesapeake:
- IDR upgraded to ‘BB’ from ‘BB-‘;
- Senior unsecured notes upgraded to ‘BB’ from ‘BB-‘;
- Senior secured revolving credit facility affirmed at ‘BBB-‘;
- Convertible preferred stock upgraded to ‘B+’ from ‘B’.
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