DBRS Downgrades Cenovus Energy Inc. to BBB, Changes Trend to Negative

DBRS Limited (DBRS) has today downgraded the Issuer Rating and Senior Unsecured Debt rating of Cenovus Energy Inc. (Cenovus or the Company) to BBB from BBB (high). At the same time, all trends were changed to Negative. DBRS also removed all ratings from Under Review with Negative Implications where they were placed on March 29, 2017. The rating actions follow the closing of the acquisition of Western Canadian assets from ConocoPhillips (COP; rated BBB (high) with a Stable trend by DBRS) on May 17, 2017. The one-notch downgrades account for DBRS’s view that the acquisition has a negative impact on the credit metrics of Cenovus that more than offset the improvement in the Company’s business risk profile. The Negative trends reflect execution risk and uncertainty as to (1) the timing and proceeds from asset dispositions; and (2) the Company’s ability to sufficiently reduce financial leverage in the current weak oil and gas (O&G) pricing environment in order to maintain a BBB rating.

DBRS notes the strengthening of Cenovus’s business risk profile with the acquisition. The acquisition adds scale and size to the Company’s oil sands and a second platform of growth with the acquisition of COP’s Deep Basin conventional O&G assets. The addition of the remaining 50% interest in high-quality long-life oil sands reserves from the Foster Creek Christina Lake (FCCL) Partnership fortifies Cenovus’s long proven reserve life as well as improving operating and capital flexibility. The support from these factors is partly offset by a lessening in vertical integration and increased exposure to lower-margin non-upgraded oil sands production. Also, uncapped contingency payments payable to COP tempers the cash flow contribution from the acquired FCCL Partnership assets. The payment is triggered at a Western Canada Select price of $52/barrel. DBRS notes the Company’s cash flow post-acquisition is more sensitive to commodity price volatility and to changes in the heavy-light oil price differential. Cenovus has hedged approximately 143,000 barrels/day (bbls/d) of oil production over the second half of 2017, at a West Texas Intermediate (WTI) floor price of USD 51.50/barrel (bbl) and 50,000 bbls/d of oil production for the first half of 2018, at a floor price of USD 49.70/bbl to mitigate some of the price volatility risk.

Financial leverage after the acquisition has increased and is well outside the BBB range. To reduce leverage, the Company plans to divest a large portion of its legacy conventional O&G assets. When the acquisition was announced in late March, the Company secured a $3.6 billion asset sale bridge facility for planned dispositions. At its recent investor day on June 20, 2017, the Company updated its disposition plans with a targeted range of $4 billion to $5 billion by year-end. Based on DBRS’s base oil price forecast of USD 50/bbl WTI for 2017 and USD 55/bbl for 2018 and 2019, DBRS projects Cenovus should be able to produce sufficient free cash flow (cash flow after capital expenditures and dividends) surpluses that can be directed to reduce financial leverage. If the Company is able to realize proceeds from asset sales at or above the midpoint of the targeted range and also generate enough free cash flow to adequately reduce financial leverage, DBRS may consider changing all trends to Stable. Otherwise if asset sales fall short and/or if oil prices stay weak for an extended period, DBRS may take a further negative rating action. The Company has adequate liquidity. At June 30, 2017, the Company estimates $4.4 billion to be available on $4.5 billion of credit facilities and, exclusive of the asset sale bridge facility, there are no long-term debt maturities until late 2019.

Notes:
All figures are in Canadian 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 principal methodology is Rating Companies in the Oil and Gas Industry (September 2016), which can be found on dbrs.com under Methodologies.

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.