S&P Lowers Outlook on SM Energy (SM) to Negative; Ratings Affirmed

August 10, 2016 9:22 AM EDT

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S&P Global Ratings today affirmed its 'BB-'corporate credit rating on SM Energy Co. (NYSE: SM), and revised the outlook to negative.

At the same time, we affirmed the 'B+' issue-level rating on the company's senior unsecured debt, with a recovery rating of '5', indicating our expectation of modest (10% to 30%, upper half of the range) recovery to creditors in the event of a payment default.

SM Energy Co. announced it has entered into a definitive agreement to purchase 24,783 net acres in the Midland Basin from Rock Oil Holdings LLC (not rated) for $980 million. The acquisition will be funded with an equity offering, asset sales, and debt. The acquisition is largely contiguous and more than doubles the company's acreage position in the Midland Basin. However, the acquisition is mostly undeveloped acreage and will require additional capital expenditures to bring on production.

"We continue to assess SM Energy's business risk profile as fair," said S&P Global Ratings credit analyst David Lagasse. "The company's financial risk profile remains aggressive, however, at the lower end of the range," he added.

The negative outlook reflects our expectations that FFO to debt will approach 12% because of increased debt levels, weaker cash flows resulting from lower hedges in 2017, and increased capital expenditures to support recent acquisitions.

We could lower the rating if we expected the company to sustain FFO to debt below 12%, which could occur if SM Energy's production fell more than projected or if hydrocarbon prices averaged below our price deck assumptions. We could also lower the rating if the company were unable to maintain its proved developed reserve life at current levels.

We could revise the rating to stable if the company is able to stabilize cash flows, such that FFO to debt is sustained comfortably above 12% under current industry conditions.

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