DBRS Downgrades Encana Corporation to BBB (low), Negative

DBRS Limited (DBRS) has today downgraded the Issuer Rating and the Unsecured Senior Notes and Medium-Term Notes & Debentures ratings of Encana Corporation (Encana or the Company) from BBB to BBB (low). The rating downgrade reflects the significant erosion in the Company’s credit metrics as a result of the weak oil and gas pricing environment. Encana’s production is more heavily weighted towards natural gas compared to its peer group and the steep decline in natural gas prices in the United States and Canada, in combination with the drop in the price of oil, has resulted in a significant contraction in cash flow generation. DBRS expects natural gas prices in North America will remain weak over the near term, causing further pressure on the Company’s financial profile. Consequently, DBRS is maintaining all trends as Negative.

In 2015, The Company has taken a number of steps to reduce debt through asset sales (approximately $1.9 billion in 2015) and an equity offering (approximately $1.1 billion). Further announced asset sales (the DJ Basin assets in the United States and Gordondale in Alberta to close this quarter) are expected to provide estimated gross cash proceeds of close to $1.4 billion. These funds can be deployed to further strengthen the Company’s balance sheet. Nonetheless, the reduction in cash flow has outpaced the reduction in debt, leading to weaker credit metrics. Furthermore, favourable commodity price hedges, which have augmented cash flow during the recent downturn, are expected to provide less price support in the future. For the last 12 months (LTM) ending March 31, 2016, the Company’s lease-adjusted debt-to-cash flow ratio was 5.32 times (x; below the BBB threshold) versus 2.81x in 2014. The lease-adjusted debt-to-capital ratio was 29.6% (within the “A” range) and the lease-adjusted EBIT interest coverage was 0.73x (below the BBB range).

Encana is transitioning from natural gas to higher-margin liquids-rich gas and light oil prospects, focusing on four core resource plays: the Permian and Eagle Ford in the United States, plus the Duvernay and Montney in Western Canada. In each area, the company operates the majority of its production and has established a significant footprint. This focus has enabled the Company to significantly reduce its overall cost structure and drive cost efficiencies. The transition provides greater product diversification and the sizable footprint provides scale. At higher oil and natural gas prices, the Company’s resource plays offer substantial lower-risk growth opportunities. Furthermore, the Company has minimal capital commitments in each of its core areas and considerable flexibility to adjust capital spending for volatile pricing. However, the Company has a shorter proven reserve life index relative to its peers (7.2 years) and requires a relatively higher level of capital investment to maintain production levels. The liquidity profile is sufficient with $222 million of cash at March 31, 2016 (to be supplemented with additional cash realized from the recent asset sales), $3.3 billion undrawn on $4.5 billion of credit facilities and no long-term debt maturities until 2019. In DBRS’s view, the Company’s business and liquidity profiles support a rating within the BBB category.

The Company has planned a reduced capital budget of $0.9 billion to 1.0 billion in 2016, and DBRS anticipates a modest free cash flow deficit (cash flow after capex and dividends) for the year. About 75% of the Company’s oil and condensate production (excluding NGLs) is hedged for the remainder of the year (May–December) at approximately $55/bbl and over 85% of the Company’s gas production is hedged at an average of approximately $2.60/mcf. Should the pricing environment improve materially or the Company takes further action to reduce debt through additional asset sales or equity issuances, DBRS may consider changing the trends to Stable. On the other hand, if a weak pricing environment persists and the Company’s key credit metrics remain beyond the rating’s range on a sustained basis, Encana’s ratings are vulnerable to further downgrades.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Companies in the Oil & Gas Industry, which can be found on our website under Methodologies.

This rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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