Fitch Ratings has upgraded Encana Corporation following its acquisition of Texas-based Newfield Corporation, to BBB, from BBB- previously. Both ratings are considered “investment grade,” with BBB being viewed as more secure.
The all-stock deal, valued at US$5.5 billion when it was announced in November 2018, closed on Feb. 13.
Fitch said the rating upgrade reflects a number of benefits for the combined company, including expanding Encana into the STACK and SCOOP fields in Oklahoma.
1. Increased size and scale
Encana will see a material increase in size and scale following the Newfield acquisition, Fitch noted.
“On a pro forma basis as of 3Q 18, Encana’s production will increase from 378,200 boe/d to approximately 577,000 boe/d (excluding China volumes), making the combined entity the second largest producer of unconventional resources in North America,” analysts said in a statement on Friday.
“The addition of the STACK-SCOOP adds a large, low-cost growth resource to Encana’s portfolio that lends itself to further efficiency gains through the application of Encana’s cube resource development model.”
The company expects approximately $250 million of annual cost savings from well improvements, primarily linked to the application of cube development to the STACK-SCOOP, as well as from unbundling of well services.
“While there is some execution risk in realizing stated acquisition synergies, Fitch believes the targets are achievable,” analysts said.
2. Faster transition to liquids
The acquisition will accelerate Encana’s transition to liquids and away from lower value natural gas with AECO pricing in Alberta, Fitch noted.
“As of 3Q, stand-alone Encana's production was approximately 47 per cent liquids, versus 41 per cent in 2017 and 35 percent in 2016. On a pro forma combined basis, the acquisition will push Encana’s liquids mix up to approximately 52 per cent and further benefit the company's netbacks,” analysts said.
“The combined company's liquids production is approximately 300,000 bbls/d. In addition to oil, growth in NGLs has been a major driver of Encana’s increased liquids output. While U.S. NGLs trade at a significant discount to West Texas Intermediate, NGLs in the Montney in Western Canada enjoy stronger pricing, given their link to local diluent requirements for oilsands blending (condensate).”
3. Greater basin diversification
The acquisition will initially expand Encana from four to eight basins by adding the STACK-SCOOP, Williston, Uinta, and Arkoma to existing positions in the Permian, Montney, Duvernay, and Eagle Ford, Fitch said.
Three quarters of the company's capex will be focused on three core growth assets: the Permian, Montney, and STACK-SCOOP.
Fitch expects the other assets may either developed at lower intensity levels for free cash flow, retained for option value, or potentially monetized, similar to the recent San Juan sale. “Fitch generally views the transition to a multi-basin set of core assets favorably, as having depth and scale in individual formations allows for efficiency gains, yet being in multiple basins allows for the shift of capital to optimize value and enhance cross-basin learnings,” analysts said.
4. Conservatively financed
The ratings agency characterized the deal as “de-leveraging” given its conservative, all stock-financing, Newfield’s relatively lower debt/EBITDA leverage versus Encana and the impact of expected synergies and combined growth on forward looking metrics.
“In our base case, we expect leverage will drop from 1.9x on a standalone basis at Sept. 30, 2018, to around 1.4x by 2020,” analysts said.
“Concurrent with the deal, Encana announced a $1.5 billion buyback program ($250 million of which was completed in 2018), and a 25 percent increase in its dividend. While returns of capital to shareholders are an increasing use of cash across the exploration and production space, Fitch expects both of these programs will be managed within existing cash balances and free cash flow.”
5. Reserve life increasing
As calculated by Fitch, Encana’s stand-alone reserve life has historically been shorter than liquids-focused peers at seven years, while premium drilling inventory has grown much faster than proved reserves, particularly in the high-growth Permian and Montney.
Fitch said it expects that the favorable impacts of acquiring longer-lived Newfield, as well as relatively robust organic reserve replacement gains, will help close this gap in 2018 and over the next few years.