Morningstar DBRS Assigns an Issuer Rating of BBB (low) With a Stable Trend to Veren Inc.

DBRS Limited (Morningstar DBRS) assigned an Issuer Rating of BBB (low) with a Stable trend to Veren Inc. (Veren or the Company).

KEY CREDIT RATING CONSIDERATIONS
Morningstar DBRS believes that the acquisitions completed by Veren in 2023 have improved the Company’s business risk profile. The acquisitions have scale with sizable operations in the Alberta Montney (2024 estimated production: 95,000 barrels of oil equivalent per day (boe/d)) and Kaybob Duvernay (2024 estimated production: 50,000 boe/d) and improved in-basin diversification. The acquired assets are located next to Veren’s existing assets and have similar characteristics with a lower cost structure. Veren expects additional synergies at the assets acquired from Hammerhead Energy Inc. (HHR) as it implements its development plan. Morningstar DBRS notes that the Company has seen similar success with the existing Montney assets that it acquired in Q2 2023. The HHR acquisition in particular has provided the Company with access to significant infrastructure that could be monetized to reduce debt.

Morningstar DBRS also notes that the acquisitions have increased the Company’s exposure to lower-value natural gas production. While the Company has access to downstream natural gas markets for a material part of its production, it is still exposed to natural gas prices, which are currently weak, and to the AECO/NYMEX differential. Morningstar DBRS notes that the Company has hedged approximately 30% of its natural gas production for 2024 and 2025, including hedges to lock in the AECO/NYMEX differential. The Company also sold its assets in North Dakota and, as a result, its producing assets are concentrated in Western Canada. While the acquisitions completed in Q4 2023 provide Veren with an opportunity to improve its cost structure by leveraging the benefits of size and scale, the Company must successfully integrate the acquired assets.

Veren’s financial risk profile weakened in 2023 because of the debt raised to fund the two acquisitions. As of March 31, 2024, Veren’s debt was approximately $3.6 billion. The Company’s capital allocation framework over the medium term includes allocating 60% of free cash flow (FCF) surplus toward shareholder distributions (base dividend and common share buybacks) and the balance to reducing leverage until it reaches its net debt target of $2.2 billion.

Morningstar DBRS notes that the sale of a few of the Company’s noncore assets concluded in June 2024 has accelerated the deleveraging process. Under its base-case commodity price assumptions, Morningstar DBRS expects Veren to generate a modest FCF surplus in 2024 and 2025, which should allow the Company to reduce leverage further. Morningstar DBRS expects the Company to maintain its lease adjusted debt-to-cash flow ratio at around 1.50 times (x). The pace of deleveraging could also quicken if commodity price assumptions trend higher than Morningstar DBRS’ base-case assumptions. For every one-dollar change in West Texas Intermediate (WTI) prices, the Company’s hedged cash flow from operations changes by $20 million for the remainder of 2024.

CREDIT RATING DRIVERS
A positive rating action is unlikely in the near term unless there is a material improvement in the Company’s business risk profile. A negative credit rating action is possible if oil prices weaken materially and the Company's debt-to-cash flow ratio stays above 2.00x for an extended period.

EARNINGS OUTLOOK
Veren is guiding for average 2024 production volumes of 191,000 boe/d to 199,000 boe/d with a liquids contribution of approximately 65%. This represents a 45% increase to the Company’s budgeted production in 2023 and is primarily driven by the acquisition of HHR. The lower liquids contribution is due to the lower liquids weighting at the assets of HHR. Morningstar DBRS expects earnings in 2024 to be lower relative to 2023 as the impact of higher production is largely offset by lower crude oil price assumptions. Morningstar DBRS also expects the Company's operating costs on a per boe basis to trend lower because of higher production, synergies from the acquisitions completed in 2023, and disposition of the higher cost noncore assets completed in June 2024.

FINANCIAL OUTLOOK
Veren has budgeted capital expenditures (capex) of $1.4 billion to $1.5 billion in 2024. The Company estimates its maintenance capex to maintain production at 200,000 boe/d to be around $1.0 billion, which implies an average WTI capex and dividend breakeven of approximately USD 50/barrel. Based on its base-case price assumptions, Morningstar DBRS expects Veren's cash flow from operations in 2024 and 2025 to be lower compared with 2023. Nevertheless, Morningstar DBRS expects the Company to generate a modest FCF surplus in 2024 and 2025, which should allow it to reduce leverage further. Morningstar DBRS expects the Company to maintain its lease adjusted debt-to-cash flow ratio at around 1.50x.

CREDIT RATING RATIONALE
The credit rating is underpinned by Veren’s (1) improved size and scale with budgeted average production of approximately 200,000 boe/d with higher value liquids accounting for nearly 65% of the production; (2) improved operating efficiency because of the acquisitions and dispositions completed in 2023; and (3) ability to quickly adjust capital expenditures and production to the prevailing commodity price environment. Key challenges to the rating include increased exposure to natural gas, the concentration of assets in Western Canada, environmental cost pressures, and the increase in leverage as a result of the acquisitions. The Stable trend underlies Morningstar DBRS' expectation that the Company's financial risk profile will remain supportive of the rating under Morningstar DBRS’ base-case commodity price assumptions.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
The following Environmental factor(s) had a relevant effect on the credit analysis: Morningstar DBRS considers the impact of both physical and transition risks associated with climate change with the transition risk deemed to be more substantial. Morningstar DBRS considered carbon and greenhouse gas (GHG) costs as a relevant environmental factor for Veren. This factor is relevant because the ever-increasing environmental regulations in Canada targeting the reduction of GHG emissions will likely limit the growth potential and add costs for all oil and gas companies in Canada.

Social (S) Factors
There were no Social factors that had a relevant or significant effect on the credit analysis.

Governance (G) Factors
There were no Governance factors that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of Veren, the BRA factors are considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of Veren, the FRA factors are considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of Veren, the BRA carries greater weight than the FRA.

Notes:
All figures are in Canadian dollars unless otherwise noted.

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Companies in the Oil and Gas and Oilfield Services Industries (April 15, 2024), https://dbrs.morningstar.com/research/431177.

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186, which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodology has also been applied:

Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024), https://dbrs.morningstar.com/research/427030.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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