HSE on Watch Negative, says S&P

Standard & Poor’s has announced (on October 1):

  • •We are placing our ratings on Husky Energy Inc. on CreditWatch with negative implications, following its announced unsolicited bid to acquire oil sands bitumen producer, MEG Energy Corp.
  • •We are also placing our ‘BBB-‘ global scale and ‘P-2(Low)’ Canada scale preferred share ratings on CreditWatch with negative implications, as we would lower them to ‘BB+’ and ‘P-3(High)’, respectively, concurrent with a downgrade on the company to ‘BBB’.
  • •We are assuming Husky’s major shareholder will retain its majority ownership in the company, so we expect the one-notch uplift to its rating, which is supported by this ownership, should remain in effect.
  • •The negative CreditWatch reflects the potential deterioration of Husky’s cash flow and leverage metrics, with the addition of MEG’s existing C$3.6 billion of debt (at June 30, 2018), and the resulting deterioration of the company’s financial risk profile, which could lead to a downgrade.

S&P Global Ratings today placed its ratings on Calgary, Alta.-based Husky Energy Inc. on CreditWatch with negative implications, following the company’s announced offer to acquire MEG Energy Corp. The estimated value of the acquisition is C$6.4 billion, which includes the assumption of MEG’s debt of C$3.6 billion, and MEG’s June 30, 2018 cash balance of C$564 million. Husky intends to issue shares from its treasury and pay C$1 billion of cash in exchange for MEG’s equity outstanding.

The negative CreditWatch reflects S&P Global Ratings’ opinion that Husky’s acquisition of MEG, with the assumption of about C$3.6 billion of debt, could weaken the company’s overall cash flow and leverage metrics below the minimum thresholds required to support the ‘BBB+’ rating. Without the company having a clearly articulated plan to delever its balance sheet immediately following the acquisition, Husky’s financial risk profile could weaken by one category, which would, in turn, cause us to lower the credit rating to ‘BBB’.

We expect to resolve the CreditWatch placement when the transaction closes. This should occur in early 2019.

DBRS commented (also on October 1):

Husky’s unsolicited offer has not been endorsed by MEG’s Board of Directors (Board). With the absence of Board support, Husky intends to commence an offer directly to MEG common shareholders by way of a takeover bid, which requires 66 2/3% of the total fully diluted shares tendered to Husky’s offer. DBRS notes the uncertainty in that Husky may not be successful with its proposal in the current form. DBRS also notes uncertainty as to (1) the time necessary to complete a successful offer and (2) the possibility that Husky may have to alter its offer to secure approval from MEG’s Board and/or common shareholders. Because of the uncertainties regarding the outcome of Husky’s offer, DBRS plans no rating action at the current time. However, should Husky be successful with its offer either in its current form or a modified form, DBRS may be compelled to take a rating action.

Nevertheless, DBRS notes that if Husky’s offer is successful in its current form, the addition of MEG’s assets would be mildly positive for Husky’s business risk profile. The inclusion of MEG’s assets (1) adds to Husky’s size, (2) improves the Company’s proven reserve life index, (3) complements Husky’s other thermal oil developments in Western Canada and (4) enhances Husky’s heavy oil integration plans. Tempering the improvement in the business risk profile is a higher level of asset concentration in Western Canada and a higher proportion of thermal oil in the Company’s production mix.

DBRS notes that Husky’s credit metrics (assuming Husky’s offer is successful in its current form) are modestly negatively affected initially due to the sizable amount of MEG debt that the Company would incur. On a pro forma basis (last 12 months ended June 30, 2018), Husky’s lease-adjusted debt-to-cash flow ratio rises from approximately 1.6 times (x) to 2.3x (outside the “A” range). However, Husky has noted that approximately $200 million in synergies could be realized annually from the acquisition of the MEG assets. Also, the combined entity is expected to generate material free cash flow (cash flow after capital spending and dividends) that can be deployed to reducing net debt and financial leverage. The Company anticipates a net debt-to-cash flow ratio of the combined entity (based on current strip pricing in 2019 for West Texas Intermediate oil of USD 70.50/bbl and a heavy light oil differential in Western Canada of USD 26.26/bbl) to be approximately 1.0x in 2019.

Affected issues are HSE.PR.A, HSE.PR.B, HSE.PR.C, HSE.PR.E AND HSE.PR.G.

Update, 2018-11-11: Moody’s considers the proposed acquisition credit negative:

If the transaction closes as structured it would be credit negative for Husky because of its leveraging nature and increased exposure to heavy oil differentials, but should be absorbed within Husky’s currently strong financial position and we would likely affirm Husky’s ratings.

Husky would benefit from the addition of MEG’s high quality, long-lived reserves, a well understood reservoir with an established history of performance, future development opportunities, and a doubling Husky’s proved reserves. However, the assumption of MEG’s high Moody’s adjusted debt of about C$3.7 billion would be leveraging, reducing Husky’s expected 2019 retained cash flow to debt to about 35% from 45%. The addition of 2019 bitumen production would reduce Husky’s currently full integration of North American bitumen and heavy oil production, increasing its exposure to heavy oil differentials.

Husky (Baa2 stable) benefits from: 1) its integrated North American onshore upstream and downstream refining operations that provide diversity and lessen cash flow volatility; 2) the favorably priced contracts for its natural gas production offshore China; and 3) favorable cash flow-based leverage and interest coverage metrics. Husky is challenged by: 1) its exposure to volatile commodity prices in its North American heavy oil and natural gas segments and; 2) low margin upstream production, particularly at its Sunrise operation.

4 Responses to “HSE on Watch Negative, says S&P”

  1. skeptical says:

    Quick question:
    How do you respond to such news from a risk management perspective?
    Assuming you have a portfolio of 15 good P(2L) and above issues with equal weights. Do you sell these issues when the credit rating is lowered below that level?
    Or you let it ride and weather the storm, hoping that ratings would improve?
    Then at what point do you cut losses?
    Thanks much!

  2. jiHymas says:

    I don’t pay too much attention to Credit Watches and Trends, except at the very low end of the preferred universe that’s eligible for purchase.

    Do you sell these issues when the credit rating is lowered below that level?

    No. Forced sales and investor angst at the time of a downgrade are so common that it’s a good bet that the price of the issue has been depressed beyond all reason. I simply adjust the credit rating on HIMIPref™ (which affects the estimate of Fair Value) and trade the issue normally.

  3. skeptical says:

    Thanks for the prompt response. What level is this:

    “very low end of the preferred universe that’s eligible for purchase.”
    Is it P(2L) and above?

  4. jiHymas says:

    No, Pfd-3(low) and above. My issuer exposure limit for Pfd-3 issues is much lower than the limit for investment-grade; as well, there is a total exposure constraint on junk issues.

    Note that these are soft caps! A major design parameter for HIMIPref™ is that trades should never be forced. Strongly encouraged, sure, with optimization of the degree of encouragement, but not forced.

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