Moody's cuts Chesapeake Energy notes to B3
(Press release provided by Moody's Investors Service)
NEW YORK, Dec 21 - Moody's Investors Service downgraded to B3 from B1 Chesapeake Energy's senior unsecured guaranteed note ratings on four issues totaling $920 million, and to ''ca'' from ''caa'' its rating on $230 million of 7% cumulative convertible preferred stock.
The company omitted its preferred dividend.
A $50 million secured bank revolver from a single bank ($25 million drawn) is unrated.
The notes, which are at the parent, are structurally subordinated to secured bank debt at subsidiaries and the indentures permit as much as $150 million of secured debt.
The senior implied rating is B2.
These actions conclude a review for downgrade initiated by Moody's in July 1998.
Moody's will track price, production, liquidity, and finding and development cost trends.
Chesapeake's dominant business problem traces to past decisions to leverage previously flush but very short-lived, and extremely capital intensive, Texas Austin Chalk cash flows in order to double-up on similar geology and economics with exploration properties in the Louisiana Austin Chalk.
The Louisiana strategy was pursued instead of a proactive conventional redeployment and diversification of then prodigious Austin Chalk cash flows into longer-lived plays.
Most of the Louisiana properties have been written off, Texas Chalk production peaked and started its inevitable decline, and prices are weak.
Both Chesapeake's and the oil and gas sector's equity prices collapsed and the firm was forced in haste into largely debt-fund acquisitions of longer-lived reserves in the U.S. Mid-continent.
Though the firm's reinvestment risk is reduced with a longer reserve life, Chesapeake is highly leveraged during extended weak prices, and it needs to deliver sustained operating success with its new strategy.
The B3 note rating anticipates a potential for increased effective and structural subordination if Chesapeake needed or chose to supplement liquidity with increased senior secured funding, and was able to arrange such funding.
The B2 senior implied rating anticipates that Chesapeake will not execute a sale of itself, but that it could have sufficient liquidity to cover interest and capex requirements well into 1999, or through 1999 if key very important assumptions are made, including realized unit prices, replacing production within its announced $100 million capex budget, and meeting its drilling unit economics targets, as it tries to bridge to firmer natural gas prices.
A relatively warm winter to-date adds to the 1999 challenges. The ratings outlook could erode in 1999 from sustained price weakness, disappointments in production rates or drilling economics, or if surprises surface in the firm's year-end engineering report.
Moody's does not anticipate reinstatement of preferred dividends in the near future. Reinstatement would require sustained price relief, substantial improvement in finding and development costs, and stable to growing production.
Still, the note ratings could eventually have upside if natural gas prices have a sustained rebound, production meets company targets, unit finding and development costs improve to norms within the core basins in which Chesapeake now operates, and if the company has not incurred substantial senior secured debt.
An outright sale of the company is unlikely. The impact of weak sector commodity and equity markets on potential buyers and on their assessments of reserve values, Chesapeake's excessive preferred stock and debt (with change of control puts) burden on reserves, and its still-declining production, impede a sale for what Chesapeake believes to be fair value.
Moody's believes an outright sale of the firm is unlikely for the foreseeable future. The downgrades reflect prior missed projection targets, weak prices, high interest burden on cash flow and high leverage on reserves, and the still uncertain floor at which new Chesapeake's production will stabilize.
The ratings do reflect: a potential 1H99 stabilizing of production as Austin Chalk production shrinks as a component of production; visible liquidity to fund essential capex in 1999; and a more diversified 200mmboe to 215mmboe of proven reserves (30% proven undeveloped) that provides a limited degree of flexibility to augment liquidity with asset sales during the price trough.
The company's debt and interest burdens, and drilling results require a stronger price environment in order for post-interest cash flows to sustain minimum full reserve replacement capex.
Under current prices, the company is prone to require external funding to meet minimum reserve maintenance capex.
Still, Chesapeake believes that late 1998 and 1999 reserve replacement costs are falling into a pattern typical for lower risk and cost Mid-continent drilling.
Chesapeake believes that visible cash flow and bank liquidity may cover its 1999 reserve replacement capex if it can deliver on its 1999 forecast of $4.10/boe of finding and development costs.
The company believes that drilling results were in the range of $6/boe during most of 1998 and were in the range of $4.50/boe by 4Q99.
Chesapeake's Louisiana Austin Chalk failures, several strategic acquisitions, and a fundamental shift to a Mid-continent focus greatly cloud evaluation of expected drilling economics.
However, annualized run-rate production of 23mmboe, multiplied by 3Q98 unit cash operating margins of $8.10/boe, imply a potential $186 million of 1999 EBITDA, assuming 3Q98 realized prices apply.
This would cover Moody's estimate of $85 million in cash interest by 2.2x and interest expense plus Chesapeake's estimate of minimum reserve replacement capex of $100 million by approximately 1x.
Weaker pricing or production, or higher finding and development costs, would erode that coverage, but $25 million of cash balances and $25 million of undrawn bank revolver may supplement cash flows.
The company believes its annualized run-rate reserve life is 6.5 years on proven developed reserves (approximately 150mmboe) and 9.3 years on total proven reserves (approximately 215mmboe).
To benefit from its approximately 65mmboe of proven undeveloped reserves (PUD), Chesapeake must eventually spend $220 million of drilling and completion capex to bring PUD reserves to production.
The company will focus its capex on PUD activity in 1999. The company reports that 90% of PUD reserves and 80% of total proven reserves have been evaluated by third-party engineering.
Ryder Scott has engineered 65% of reserve values and Williams engineered 15% of values (all in the Austin Chalk). Given Chesapeake's leverage burden, the firm will need to deliver a relatively successful drilling program in 1999.
Chesapeake requires price relief or deleveraging to ensure full reserve value coverage of debt. At gas and oil prices of $2/mcf and $11/boe, respectively, Chesapeake estimates SECPV10 reserve values to be $700 million (or $0.54/mcfe) net of PUD capex, though this likely understates value in an actual sale.
Chesapeake currently estimates proven reserves of 1.295tcfe or 216mmboe (151mmboe proven developed) after the sale of Pan East to Poco Petroleums for $26 million.
With $920 million of notes and $25 million of outstanding bank debt, this implies current Total Debt/Total Proven Reserves of $0.73/mcfe ($4.37/boe) and Total Debt/Proven Developed Reserves of $6.25/boe ($1.04/mcfe).
A more accurate measure of the total cash claim burden on proven reserves would add Chesapeake's future required development capex to its total debt obligation.
The $220 million of required development capex on 65mmboe of proven undeveloped reserves, when combined with $945 million of total debt, yields an implied Debt/Proven Reserves of $0.90/mcfe ($5.40/boe).
During 3Q98, Chesapeake generated $8.10/boe of operating cash flow, covering $3.41/boe of cash interest expense (including capitalized interest) by 2.4x.
If 3Q pricing and production levels continued, 3Q98 unit cash flow after interest expense of $4.69/boe may not be far out of line with unit finding and development cost norms in Chesapeake's longer-lived core areas.
However, 3Q98 unit cash flow is dwarfed by historic unit reserve replacement costs (though distorted by Austin Chalk failures) and 3Q production still captured benefits from higher but still declining Austin Chalk production. in 1999.
Sustained improvement in drilling economics is vital in 2H98 and 1999 for the firm to live within cash flow and visible liquidity in hopes of bridging to price recovery.
Moody's will soon assess 1998 reserve replacement results and third-party engineering. Given massive reserve revisions and property write-offs arising largely from the Louisiana Austin Chalk effort, as well as from full-priced acquisitions of longer lived assets, the firm's three-year average all-sources finding and development costs soared to $12.90/boe through 1997 and $16.05/boe in 1997 alone.
The company believes its 1998 drillbit finding and development results will approximate $6/boe, trending lower in 3Q and 4Q98.
The firm's book equity was eliminated by both property writedowns and ceiling test writedowns. A currently weak natural gas price environment may expose the firm to further ceiling test writedowns.
The note issues affected by today's actions are Chesapeake's $500 million of 9.625% notes due 2005, $150 million of 8.5% notes due 2012, $150 million of 7.875% notes due 2004, and $120 million of 9.125% notes due 2006.
The notes are joint and severally guaranteed by Chesapeake's principal operating subsidiaries. Chesapeake Energy Corporation is headquartered in Oklahoma City. Approximately 60% of the company's reserves are located in the Mid-Continent region, with the remainder in the Austin Chalk (15%), Western Canada (20%), and 5% in the Williston and Permian Basins.
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Think I'll pass on this one for a few months. Once the 4th quarter results are out (including the ceiling writedown) I'll take another look.
Time to look at companies that are not burdened with so much debt. |
