Fitch Assigns Initial Ratings to Jones Energy; Outlook Stable
The Rating Outlook is Stable.
KEY RATING DRIVERS
Ratings for JEH reflect a competitive full-cycle cost structure, strong hedge positions and defensive hedging philosophy, reasonable credit metrics for the category, and an adequate liquidity profile considering the 2015 investment program. Company strengths are offset by small size, geographic concentration, and the potential for sustained lower oil and natural gas prices, which places additional importance on lowering drilling and production costs and maintaining adequate hedge coverage.
COMPETITIVE FULL-CYCLE COST STRUCTURE
JONE has a long track record in its primary basin (Cleveland Basin, located in the OK and TX Panhandle), and has developed and improved drilling & completion techniques specific to the Cleveland. This allows the company to achieve competitive internal rates of return (IRRs) by reducing costs in a lower commodity price environment. JONE has lowered well costs approximately 32% thus far in 2015 (from $3.8 million/well to $2.6 million/well), driven largely by reductions in frac services and rig rates. JONE generated cash netbacks of $29/boe in 2014, which is competitive with liquids-focused peers.
Fitch views the company's focus on returns rather than production volumes as a credit-positive considering its asset size and positioning in the context of a challenging commodity price environment. Over 80% of acreage is held by production, reducing the need to spend additional capital to hold lease positions. The company's production mix for the first half of 2015 (1H15) was 30% oil, 27% NGL, and 43% natural gas.
GOOD HEDGE POSITIONS THROUGH 2016
JONE's hedge positions provide significant cash flow protection and serve to differentiate JONE from high-yield E&P peers. The company has a track record of aggressively hedging production volumes through a variety of commodity price environments. This provides increased confidence in cash flow and credit metrics forecasts due to more certainty on top-line forecasts. JONE currently has 100% of 2H15 oil hedged at $84.11/bbl. For 2016, on a barrel of oil equivalent basis, JONE has 75% of expected oil and natural gas production hedged at prices of $82.74/bbl for oil and $4.44/mcf for gas. The mark-to-market value of hedges was $220 million as of the company's 2Q earnings release on August 6.
REASONABLE CREDIT METRICS
As calculated by Fitch, JONE debt/EBITDA was 3.2x at June 30, 2015. Fitch expects leverage of 3.5x and 3.7x in 2015 and 2016, respectively, driven by moderately lower hedge coverage and Fitch's base case price deck. Interest coverage is expected to remain above 4x in 2015 and 2016. While out-year credit metrics will depend in part on the path of future commodity prices and the ability of JONE to economically hedge, Fitch believes that metrics will remain in line for the rating at our base case price deck (long term: $70/bbl oil, $3.75/mcf natural gas).
ADEQUATE LIQUIDITY POSITIONING
JONE was active in the capital markets in 1H15, issuing $123 million in equity and selling $250 million in senior notes, terming out credit facility borrowings, and bolstering liquidity. JONE had total liquidity of $485.5 million at June 30, consisting of $23 million in cash and $462.5 million available on the credit facility. The company's liquidity position is adequate relative to Fitch's cash flow forecasts, which are helped by lower capex in 2015 and cash flow uplift from hedge positions. JONE's borrowing base was affirmed at $562.5 million in April 2015, indicating that the bank group is taking a constructive view of JONE's ability to economically produce the reserve base.
GEOGRAPHIC CONCENTRATION
JONE's single-basis focus in the Cleveland has both positive and negative credit quality factors. On one hand, a single-asset focus has allowed the company to eke out production efficiencies and asset-specific techniques, with lower costs relative to basin peers. On the other hand, JONE is uniquely exposed to the geology of the Cleveland, including expected ultimate recoveries, decline rates, and issues including local rig availability and changes in service costs. Fitch believes the positives outweigh the negatives in the case of JONE, but a single-basin focus does serve to limit ratings upside in the near term.
SMALL SIZE RELATIVE TO PEERS
JONE 2015 YTD production was 25,862 barrels of oil equivalent per day, which is small relative to Fitch's actively monitored E&P peer universe. Fitch believes that, while the current rating is supported by the other factors mentioned, ratings upside will likely be limited in the near-term due to size and asset diversity issues.
RECENT FINANCIAL PERFORMANCE
As calculated by Fitch and including the effect of settled derivative contracts, LTM free cash flow (FCF) was negative $210 million at June 30, 2015, driven by higher capex run rates in the last half of 2014. Fitch expects that lower capex exit rates in 2015 will lead to a FCF neutral-to modestly negative position, with leverage under 4x, in the current commodity price environment. Current hedge positions will provide meaningful amounts of cash flow protection through 2016, and give the company some flexibility in managing production growth relative to changes in commodity prices.
RECOVERY ANALYSIS
JONE recoveries are estimated as outstanding ('RR1' - 100%) at the first-lien secured level and as average ('RR4' - 31% to 50%) at the unsecured level. Recovery estimates are influenced by reduced value estimates for oil and gas reserves. Recovery values are based on estimated liquidation values of proved (1P) reserves. Fitch begins with a standard value of $12.50/boe for an average producer based on our long-term price deck ($70/bbl oil, $3.75/mcf natural gas). Fitch makes adjustments for location and quality, oil & gas mix, as well as adjustments related to the recent decline in commodity prices.
KEY ASSUMPTIONS
--WTI oil prices of $50/bbl in 2015, $60/bbl in 2016, increasing to $70/bbl in 2018;
--Natural gas prices of $3.00/mcf in 2015, increasing to $3.75/mcf in 2018;
--Production volumes grow at a 4% CAGR through 2018;
--2015 capex is consistent with management guidance of $240 million. In out-years, capex trends in-line with the price deck and supports higher YoY production growth in 2017-2018;
--Existing hedge positions protect cash flow through 2016, with more modest protection in 2017 and 2018.
RATING SENSITIVITIES
Positive: Future developments that may lead to positive rating actions include:
--Growth in production volumes and EBITDA leading to production greater than 50 mboe/day and/or EBITDA over $500 million;
--Maintenance of debt/EBITDA in the 3.5x-4.0x range and debt/Proved Developed in the $14-$16/boe range;
--Maintenance of a balanced financing policy and an adequate hedging program for growth in the face of higher commodity prices.
Fitch views positive rating actions as unlikely in the near term. Pressures from lower commodity prices will likely inhibit production growth, which will be a key factor in improving credit quality.
Negative: Future developments that may lead to negative rating actions include:
--Debt/EBITDA sustained above 5x, driven by the inability to hedge future production at economic prices or increases in debt,
--Debt/PD of $17-$18/boe;
--Adoption of less conservative hedging policy, leading to reduced visibility on cash flows and increased vulnerability to sustained lower oil and gas prices;
--Significant reduction in liquidity following aggressive use of revolver for growth, or lower borrowing base redeterminations.
FULL LIST OF RATING ACTIONS
Fitch assigns the following ratings:
Jones Energy Holdings, LLC (JEH)
--Long-term Issuer Default Rating (IDR) 'B';
--Senior secured first lien revolver 'BB/RR1';
--Senior unsecured notes 'B/RR4'.
The Rating Outlook is Stable.
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