HSE Downgraded To Pfd-3(high), Trend Negative by DBRS

DBRS has announced that it:

downgraded Husky Energy Inc.’s (Husky or the Company) Issuer Rating and Senior Unsecured Notes and Debentures rating to BBB (high) from A (low), its Commercial Paper rating to R-2 (high) from R-1 (low), and its Preferred Shares – Cumulative rating to Pfd-3 (high) from Pfd-2 (low). All trends are Negative. DBRS Morningstar also removed the ratings from Under Review with Negative Implications, where they were placed on March 26, 2020.

Under normal circumstances, Husky’s downstream refining assets provide a buffer against lower crude oil prices; however, the coronavirus has caused a simultaneous and steep decline in demand for crude oil and refined products. Consequently, DBRS Morningstar expects earnings at the Company’s upstream and downstream segments to be materially weaker in 2020 relative to 2019. In response to the current downturn, Husky has reduced its budgeted capital expenditures (capex) by 50% in 2020 to between $1.6 billion and $1.8 billion; reduced its common dividend payments by 90%; curtailed lower-margin production; and initiated cost-reduction measures. Despite these measures, DBRS Morningstar expects the Company to generate a material free cash flow (FCF; cash flow after capex and dividends) deficit in 2020 under its base-case Western Texas Intermediate and Brent price assumption of USD 32 per barrel (/bbl) and USD 37/bbl, respectively. Husky will likely fund the FCF deficit primarily from available cash balances ($1.3 billion at March 31, 2020). DBRS Morningstar anticipates that, as coronavirus lockdowns ease, demand and margins in the downstream segment will recover faster and stronger relative to the upstream segment. Based on DBRS Morningstar’s price forecasts, it expects the Company to generate a modest FCF surplus in 2021, which should increase materially in 2022 as Husky benefits from higher commodity prices, lower capex, and reduced dividend payments. DBRS Morningstar forecasts that gross debt levels will remain relatively flat, but also expects key credit metrics under its base-case commodity price assumptions to remain weak in 2020 and 2021 before improving in 2022 (lease-adjusted debt-to-cash flow at or around 2.0 times) as earnings and operating cash flow increase because of higher commodity price assumptions and the Company uses FCF surplus to reduce debt. However, the improvement in credit metrics is not sufficient to support the previous A (low) rating, leading to a downgrade.

The Company’s size, highly integrated heavy and thermal oil business, capital flexibility, and portfolio of lower-cost growth opportunities underpin its business risk profile, which supports the BBB (high) rating. Factors tempering the ratings include the Company’s higher percentage of production from Western Canada, relatively shorter proved developed reserve life, and a reserve base geared more toward heavy and thermal oil (69% of total proved reserves at YE2019). The majority equity stake held effectively by Mr. Li Ka-shing’s family trust and indirectly by CK Hutchinson Holdings Limited, which has been important in the implementation of Husky’s growth plans, also supports the ratings.

DBRS Morningstar notes that Husky has maintained a relatively conservative financial profile relative to most of its domestic peers. The Company has built up a sizable cash balance that should allow it to navigate the current downturn without a material increase in gross debt, but the improvement in key credit metrics is predicated on higher crude oil prices and improved refining margins. DBRS Morningstar’s approach is to rate through the cycle and give due weight to projected credit metrics when it anticipates a return to more normalized market conditions; however, the outlook for demand remains fluid and there is a risk that the recovery in commodity prices may fall short of DBRS Morningstar’s base-case price assumptions and Husky’s overall financial risk profile will not support the current ratings. The Negative trends reflect this risk, which DBRS Morningstar assesses to be elevated.

DBRS Morningstar believes that the Company has sufficient liquidity to navigate the current downturn. Husky’s committed credit facilities consist of two tranches: $2.0 billion maturing in June 2022 and $2.0 billion maturing in March 2024. As at March 31, 2020, the Company had $3.0 billion available under its committed credit facilities and $1.3 billion in available cash balances. In April 2020, the Company also availed a $500.0 million committed credit facility with a two-year term. Husky’s long-term debt maturities over the next three years are reasonable with USD 500 million maturing in 2022. DBRS Morningstar expects the Company to repay the maturities primarily from FCF surplus under DBRS Morningstar’s base-case price assumptions. DBRS Morningstar also expects Husky to remain in compliance with the applicable covenant on the credit facilities, including debt-to-capitalization of less than 65%, even if commodity prices trend lower than expected.

DBRS Morningstar may change the trend to Stable if the demand/supply dynamics in the crude oil markets continue to improve, leading to greater confidence that commodity prices and, consequently, the Company’s key credit metrics improve in line with DBRS Morningstar’s base-case assumptions. Conversely, DBRS Morningstar may take a negative rating action if commodity prices and key credit metrics fall below DBRS Morningstar’s expectations.

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

The DBRS Review-Negative was reported on PrefBlog in March. HSE is also Outlook-Negative at S&P.

8 Responses to “HSE Downgraded To Pfd-3(high), Trend Negative by DBRS”

  1. stusclues says:

    “DBRS Morningstar believes that the Company has sufficient liquidity to navigate the current downturn.”

    And yet, despite having the same rating as the FTS issues (except for the negative trend bit), the market is demanding a ~3% higher spread for the four HFC issues. This is highly unreasonable and ripe to change.

  2. peet says:

    ” …despite having the same rating as the FTS issues (except for the negative trend bit), the market is demanding a ~3% higher spread…”

    Stusclues, I too hold a lot of HSE and will continue to hold, but I see a big difference between the DBRS 3H ratings for Fortis and Husky. DBRS in its latest report has a positive trend on Fortis, rising free cash flow, and the distinct possibility of an upgrade, to name but a few. S&P actually has it at 2M. Husky, by contrast … well, you read it above.

    On a more general level, I do wonder sometimes how much credit ratings matter, especially in the world of resets and the seeming focus on the 5-year GOC and the next reset date. Look at the Enbridge resets, which are all over the map but in many cases with market yields only 1+% or so lower than comparable Husky …but Enbridge has a better credit rating [3H, 2L]. And even in the world of perpetuals, look at the Fortis “F” and “J” perpetuals trading at the same yield as CU Inc’s CIU.PR.A, rated

  3. peet says:

    …..”rated 2H”!

  4. stusclues says:

    peet, I agree that FTS is superior to HSE. Just not enough to justify a 3% spread differential.

  5. brian says:

    Cenovus is acquiring/merging with Husky!

    “Husky will also seek the approval of at least two-thirds of the votes cast by holders of outstanding Husky preferred shares voting together as a single class. If Husky preferred shareholder approval is obtained, each Husky preferred share will be exchanged for one Cenovus preferred share with substantially the same commercial terms and conditions as the Husky preferred shares. The transaction is not conditional on Husky preferred shareholder approval and, if not obtained, the Husky preferred shares will remain outstanding in a subsidiary of the combined company.”

    Can’t wait till tomorrow to see what affect this will have on Husky prefs.

  6. avocado says:

    This summer both Husky raised some cash via unsecured notes at 3.50%, and Cenovus did the same but at 5.375%. I’m surprised by the large spread between these notes which could only make me think cenovus has worse credit quality than husky. We’ll see what happens.

  7. peet says:

    DBRS has today put Husky under review with negative implications.

    “DBRS Morningstar expects the Combined Entity’s financial risk profile over the forecast period to 2022 to be weaker relative to Husky’s stand-alone financial risk profile because of a material increase in debt ( … ) and combination with Cenovus’s weaker financial risk profile.
    …Assuming the transaction closes as described in the plan of arrangement and based on DBRS Morningstar’s assumptions, the ratings of Husky by close is likely to be one notch lower than its current ratings.”

  8. somenoob says:

    I hung on to some HSE.PR.E in an account on the theory it would pop if Li Ka-Shing were to take the company private and these needed to be redeemed. Interested to see how the pref market responds to this news on Monday… I imagine downgrades and uncertainty won’t be good for a first reaction. But should any initial downdraft be taken as a pref buying opportunity for someone with cash on the sidelines, and not too averse to risk? So I’m even more interested to hear what you see ahead, James… Thank you for this blog!

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