S&P Lowers Outlook on Devon Energy (DVN) to Negative; Ratings Affirmed
Standard & Poor's Ratings Services said it revised its outlook on Devon Energy (NYSE: DVN) to negative from stable and affirmed all of its ratings on the company, including the 'BBB+' corporate credit rating.
The outlook revision reflects expected deterioration in Devon's credit-protection measures in 2016 due to low oil and gas prices, rolling off of the company's hedges, and use of debt and hybrid securities to fund a portion of the $3.45 billion acquisitions. Devon announced plans to acquire privately held Felix, which holds oil-rich properties in the "STACK" play in Oklahoma, for $1.9 billion, and in a separate transaction, to buy oil and gas properties in the Powder River Basin for $600 million. Devon's MLP subsidiary EnLink also announced plans to buy Felix's midstream operations for $1.55 billion.
"We view the transactions as generally favorable for Devon's business risk, as they add sizable complementary acreage with large inventories of light oil drilling locations, though relatively little current production," said Standard & Poor's credit analyst Ben Tsocanos.
The midstream acquisition provides strategic and cost advantages to Devon's STACK operations. We project debt leverage, however, to deteriorate to about 32% funds from operations (FFO) to debt in 2016 pro forma for the transaction, which is below our expectation of 45% for the current rating. We expect Devon to fund about one-half of the upstream purchase price with the issuance of common equity, and the remainder with debt proceeds.
We expect EnLink to fund the midstream acquisition with a combination of common equity, hybrid securities, and debt issuance. The increase in debt, combined with lower projected cash flow next year due to rolling off of commodity price hedges, results in higher leverage. We project FFO to debt to improve back above 45% in 2017 and 2018 based on a recovery in oil and natural gas prices under our current price deck assumptions. In addition, Devon has identified assets for potential divestiture, which could provide funds to repay debt and reduce leverage more quickly. The company has a good track record executing asset sales following leveraging transactions. Nevertheless, we view the current market for oil and gas properties as soft and the timing and amount of the sales as uncertain.
The negative outlook reflects our expectation that credit-protection measures will be weak for the rating over the next year. We view Devon's debt-reduction plan, which relies on light oil production growth and asset sales, as incorporating meaningful execution risk.