Fitch Downgrades Southwestern Energy Co to 'B+'; Outlook Negative

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has downgraded Southwestern Energy Company's (Southwestern; NYSE: SWN) Long-term Issuer Default Rating (IDR) to 'B+' from 'BBB-'. The Rating Outlook remains Negative.

The downgrade reflects the impact that significantly weaker natural gas prices, higher basis differentials for the Appalachia region, and lower near-term production have on Southwestern's projected leverage metrics, as well as Fitch's expectation that the company's options to generate additional liquidity have become increasingly limited in the current realized price environment. On February 24th Fitch revised its energy price assumptions lower, including a base case gas price of $2.25/thousand cubic feet (mcf) in 2016 and $2.50/mcf in 2017 and a stress case gas price of $1.95/mcf in 2016 and $2.25/mcf in 2017. Spot market gas prices, meanwhile, have been in the $1.70/mcf range recently mainly due to weak, El Nino-linked winter heating demand and historically high storage levels.

Another consideration was the negative impact that very weak realized prices have had on the company's ability to address its capital structure. Management's current focus on early stage and undeveloped acreage for divestiture will help maintain its core positions, but likely reduces potential asset divesture proceeds and near-term liquidity prospects. This heightens the credit profile's reliance on an improving realized price environment.

The Negative Outlook reflects the limitations that Southwestern's capital structure and revolver-oriented liquidity position has placed on its operational and financial profiles. Weak realized prices and considerable financing costs have constrained the company's cash flow profile. In order to maintain a neutral free cash flow (FCF) profile, management has decided to suspend all drilling activity reducing capex to $125 million in 2016 from approximately $1.8 billion in 2015. While reducing near-term liquidity needs, this decision is expected to result in a steep 15% average and 27% exit production rate drop for 2016. Fitch recognizes that company-owned service equipment allows for cost and operating flexibility, but believes that the operational momentum loss will require a considerable amount of capital and time to reverse production trends. This may be a challenge in a weak realized pricing environment.

Fitch believes there is heightened event risk that the company may look to address its capital structure to alleviate these constraints. This could include the issuance of equity or equity-like securities, secured debt, or, possibly, an unsecured-for-secured exchange. Fitch's assumption is guided by recent market activity by stressed E&P peers that have also used different ways to create liquidity and/or capital structure relief. Fitch notes that the company, as defined in its credit agreement, could incur secured debt of up to 15% of consolidated net tangible assets. For the most recent fiscal quarter, Fitch estimates secured debt capacity under this covenant to be approximately $1.1 billion.

Approximately $4.7 billion in debt is affected by today's rating action. A full list of ratings actions follows at the end of this release.

KEY RATING DRIVERS

Southwestern's ratings are supported by its size, favorable Marcellus and Utica acreage positions, solid midstream asset base, and strong operating history. Offsetting factors include the company's heightened credit risk in a weak realized price environment following its leveraged December 2014 acquisition of Southwestern Appalachia acreage, nearly exclusive natural-gas focus that results in lower netbacks per barrel of oil equivalent (boe) relative to liquid peers, and limited geographic diversity.

The company reported net proved (1p) reserves of 6.2 trillion cubic feet equivalent (Tcfe; approximately 95% natural gas) for the year ended 2015, which is down over 40% mainly due to price revisions to undeveloped reserves. Production has grown over 27% year-over-year to nearly 2.7 billion cubic feet equivalent per day (Bcf/d) for the year ended 2015. This increase is attributable to the integration of nearly 0.4 Bcf/d of the acquired Southwestern Appalachia production and about an equal amount of organic growth within the Northeastern and Southwestern Appalachia properties offset by production declines in the Fayetteville and other properties.

Lower benchmark Henry Hub and realized prices have contributed to a weak Fitch-calculated unhedged cash netback of positive $0.52/mcf for the year ended 2015 compared to a positive $2.18/mcf for the year earlier period. Average Henry Hub differentials of $0.75/ mcf during 2015 are expected to improve incrementally as additional takeaway capacity becomes available over the medium term. Fitch highlights that the company's 2016 cash breakeven price is approximately $2.40/mcf, including differentials, cash operating costs, cash interest and preferred dividends, based on management guidance and Fitch estimates.

FORECAST CASH FLOW AND UPSTREAM METRICS WIDEN

Fitch's base case forecasts Southwestern will generally be FCF neutral for 2016. Debt/EBITDA is estimated to increase to over 9.1x in 2016 from approximately 3.3x mainly due to the weaker realized oil & gas market pricing environment and lower production. Debt/1p reserves and debt per flowing barrel metrics are forecast to be approximately $4.75/boe ($0.79/mcf) and $11,230, respectively.

As of Feb. 23, 2016, the company had hedges for 37 Bcf, or less than 5% of estimated production, at an average price of $2.60/mcf. Management expects to continue to opportunistically add hedges while allowing for pricing upside.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Southwestern include:

--WTI oil price that trends up from $35/barrel in 2016 to $65/barrel long-term;

--Henry Hub gas that trends up from $2.25/mcf in 2016 to $3.25/mcf long-term;

--Average differential of under $0.75/mcf in 2016 followed by incremental improvements;

--Production below 2.3Bcf/d, or a 15% year-over-year decline, in 2016 followed by a rig-linked mid-single digit decline in 2017 with a moderately positive growth profile thereafter as oil & gas prices improve;

--Liquids mix, principally natural gas liquids, remains relatively flat near-term with a pause in Southwestern Appalachia acreage development;

--Capital spending is forecast to be $125 million in 2016, consistent with guidance, followed by a relatively balanced capital spending profile;

--Asset divestitures assumed to be $500 million in 2016;

--Asset sale proceeds are used to pay down the term loan.

RATING SENSITIVITIES

Positive: No positive ratings are currently contemplated over the near term given the weak oil & gas price outlook. Future developments that may, individually or collectively, lead to a positive rating action include:

For an upgrade to 'BB-':

--Demonstrated commitment to lower gross debt levels; and

--Mid-cycle debt/EBITDA less than 3.5x - 4.0x on a sustained basis;

--Mid-cycle debt/1p reserves below $5.00/boe and/or debt/flowing barrel under $20,000;

--Improving unit cost profile.

To remove the Negative Outlook at 'B+':

--Defined plan to address capital structure constraints in weak realized pricing environment; or

--Improved natural gas price outlook supported by U.S. production declines or inventory drawdowns;

--Reduction in gross debt that results in a mid-cycle debt/EBITDA of less than 4.0x - 4.5x over the rating horizon.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--Failure to meaningfully address the capital structure in a weak realized pricing environment;

--Mid-cycle debt/EBITDA above 5.0x on a sustained basis;

--Mid-cycle debt/1p reserves nearing $5.50 - $6.00/boe and/or debt/flowing barrel above $22,500;

--Material loss of operational momentum and/or further weakening of the unit cost profile.

LIQUIDITY AND MATURITY PROFILE

Southwestern has historically maintained a nominal cash balance and had approximately $15 million as of Dec. 31, 2015. The company's primary source of liquidity is its $2 billion unsecured credit facility (available capacity of nearly $1.9 billion at year end 2015) maturing in December 2018. The main financial covenant is a maximum debt-to-capital ratio of 60% (management estimate of 38% as of Dec. 31, 2015), excluding non-cash asset impairments and certain other items, as defined in the credit facility agreement. Other covenants consist of additional lien limitations, transaction restrictions, and change in control provisions. The revolver contains two one-year extensions and may be increased to $2.5 billion upon lender consent.

Maturities on outstanding debt are manageable through 2018 in the current realized price environment. The 7.15% notes have annual payments of $1.2 million through 2017 with the remaining principal balance of $24.6 million due in 2018. An additional $40 million (7.35% and 7.125% notes), $950 million (7.5% and 3.3% notes), and $850 million (4.05% notes) mature in 2017, 2018, and 2020, respectively. Southwestern also issued a three-year, $750 million term loan in Nov. 2015 to refinance nearly all outstanding credit facility/CP borrowings.

MANAGEABLE OTHER LIABILITIES

The company's pension obligations were underfunded by approximately $30 million as of Dec. 31, 2015, which Fitch considers to be manageable when scaled to mid-cycle funds from operations. Southwestern's asset retirement obligation (ARO) was about $201 million as of Dec. 31, 2015, which is generally consistent with the previous year's reported obligations.

Other obligations totalled approximately $9.2 billion on a multi-year, undiscounted basis as of Dec. 31, 2015. The obligations include: $8.9 billion in pipeline demand transportation charges, $278 million in operating leases for equipment, office space, etc., and $49 million in compression services. Fitch notes that nearly $3.4 billion of the reported pipeline obligations still require regulatory approvals and additional construction efforts.

FULL LIST OF RATING ACTIONS

Fitch has downgraded the following ratings and assigned Recovery Ratings as follows:

Southwestern Energy Company

--Long-term IDR to 'B+' from 'BBB-';

--Senior unsecured notes to 'B+'/'RR4' from 'BBB-';

--Bank revolver to 'B+'/'RR4' from 'BBB-';

--Term loan to 'B+'/'RR4' from 'BBB-';

--Short-term IDR to 'B' from 'F3'

--Commercial paper program to 'B' from 'F3'.

The Rating Outlook remains Negative.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 07 Dec 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=873504

Short-Term Ratings Criteria for Non-Financial Corporates (pub. 13 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869259

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1000689

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1000689

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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View source version on businesswire.com: http://www.businesswire.com/news/home/20160309006435/en/

Fitch Ratings
Primary Analyst
Dino Kritikos
Director
+1-312-368-3150
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Brad Bell
Associate Director
+1-312-368-3149
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations
Alyssa Castelli, +1 212-908-0540
[email protected]

Source: Fitch Ratings

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