Fitch Affirms Jones Energy Holdings at 'B'; Outlook Stable
Ratings for JEH reflect reasonable credit metrics for the category, good current hedge positions and defensive through-the-cycle hedging philosophy, a competitive full-cycle cost structure and an adequate liquidity profile considering the 2016 investment program and the effects of recent stress in the oil & gas sector.
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, maintaining adequate hedge coverage, and preserving liquidity and financial flexibility.
KEY RATING DRIVERS
Solid Operator with Good Full-cycle Cost Structure
JEH has a long track record in its primary area of operation (Cleveland formation within the Anadarko Basin) and has developed and improved production techniques specific to the Cleveland. This allows the company to achieve competitive IRR's through low costs even in a lower commodity price environment. As calculated by Fitch, JEH generated unhedged cash netbacks of $5/boe in 2015, down sharply from 2014 on lower revenue but still competitive with peers with a similar production mix.
Lower Drilling Costs Support Margins
JEH has successfully lowered drilling costs by 50% since 2014, from $3.8 million in 2014 to approximately $2 million in the first half of 2016. Savings have resulted from a combination of reducing drilling days (from 26 to 18) and vendor cost reductions. While Fitch expects there will be some give back on service costs in a higher price environment, fewer drilling days is a sustainable efficiency that will allow the company to ultimately produce more oil & gas for a given amount of rigs and capex.
Good Hedge Positions Through 2017
JEH has a track record of prudently hedging production volumes through a variety of commodity price environments. From a credit perspective, this provides increased visibility around cash flows and credit metrics due to better top-line forecasts. JEH recently locked in approximately $50 million in hedge gains related to 2018-2019 volumes by entering into offsetting swap positions. Based on Fitch's base case production forecasts and hedge positions as of June 30, 2016, JEH currently has approximately 80% of 2016 oil hedged at $78/bbl, and 70% oil 2017 oil hedged at $67/bbl. The mark-to-market value of hedges was $135 million as of July 28, 2016.
Reasonable Credit Metrics for Category
As calculated by Fitch, JONE debt/EBITDA was 3.3x in 2015, up from 2.9x in 2014. Fitch expects leverage of 3.6x and 4.7x in 2016 and 2017, respectively, with 2017 serving as an inflection point where the rolling off of current hedge positions is counterbalanced by a rising price deck. Interest coverage is forecasted at approximately 4.0x in 2016 and 2017. While out-year credit metrics will depend in large part on future commodity prices and the ability to economically hedge, Fitch believes that credit metrics will remain in line for the rating at the base case price deck.
Commodity Price Headwinds
Lower oil and gas prices are a headwind for the entire E&P sector. While JEH is reasonably well-protected through 2017 via hedge positions, an extended down-cycle could begin to pressure reinvestment, production volumes, and cash flow if the company is not able to hedge future volumes at economic levels.
JEH's single-basis focus in the Cleveland has pros and cons. On one hand, a single-asset focus has allowed the company to eke out production efficiencies and asset-specific techniques and lower costs relative to basin peers. On the other hand, JEH is uniquely exposed to the geology of the Cleveland, including EURs, decline rates, and issues like local rig availability and changes in costs. Fitch believes the positives outweigh the negatives in the case of JEH, but a single-basin focus does serve to limit ratings upside in the near term.
Small Size Relative to Peers
JEH 2015 production was approximately 25 mboe/d, which is small relative to Fitch's monitored E&P peer universe. Based on limited drilling activity in the first half of 2016, the company is guiding to YoY production declines of approximately 25%, or full-year 2015 production of 17 mboe/d. Fitch believes that ratings upside will likely be limited over the next two to three years due to size, asset diversity, and the potential for loss of operational momentum.
JEH 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 values for JEH are based on estimated liquidation values of proved (1P) reserves and other tangible assets. Fitch makes adjustments for location and quality, oil & gas mix, as well as adjustments related to our long term oil & natural gas price deck.
Fitch's key assumptions within the rating case for JEH include:
--Oil prices of $42/bbl in 2016 and $45/bbl in 2017, trending upward to a long run price of $65/bbl;
--Natural Gas prices trending upward to a long run price of $3.25/mmbtu;
--Production volumes decline by 25% in 2016, then increase to approximately 21 mboe/d in 2019;
--2016 capex is set at management guidance of $90 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 2017;
--While Fitch expects JEH to layer on additional hedges opportunistically, no credit is given for potential hedges;
--Cash costs per boe are essentially flat, increasing at a 0.9% CAGR through 2018 (modestly lower near term LOE increasing in out years on service cost give-back).
Positive (individually or collectively)
--Growth in production volumes, reserves, and EBITDA leading to production over 50 mboe/day or mid-cycle EBITDA over $500 million;
--Maintenance of debt/EBITDA in the 3.5-4.0x range and debt/flowing barrel below $35,000;
--Maintenance of a balanced financing policy and an adequate hedging program for growth in the face of higher commodity prices.
Fitch views positive ratings 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 relative credit quality.
Negative (individually or collectively)
--Mid-cycle debt/EBITDA above 5.0x, driven by the inability to hedge future production at economic prices or increases in debt;
--Debt/flowing barrel greater than $45,000;
--Adoption of less conservative hedging policy, leading to reduced visibility on cash flows and increased vulnerability to lower oil and gas prices;
--Significant reduction in liquidity following aggressive use of revolver for growth, or lower borrowing base redeterminations.
Adequate Liquidity Positioning
Total liquidity is lower year over year as the company's borrowing base was redetermined lower following changes in commodity prices. The borrowing base was reduced to $410 million effective Aug. 1, 2016. Pro forma for the August borrowing base redetermination, JEH has total liquidity of approximately $284 million, consisting of $59 million in cash and $225 million available on the credit facility. Facility utilization of $185 million was driven by the company's repurchase of senior notes in the first half of 2016. This served to reduce gross debt as the purchases were at approximately 40% of par but is a moderate negative for near-term liquidity. The company also expects that the borrowing base will be increased to $425 million following the closing of the planned $27 million acquisition of assets in the Anadarko Basin. In addition, the company's hedge positions should help to support the company's near-term liquidity position.
The company has initiated an ATM program to issue incremental equity during the balance of 2016. While a positive factor, Fitch expects that total amounts received under the ATM in 2016 will be modest.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Jones Energy Holdings, LLC (JEH)
--Long-term Issuer Default Rating (IDR) at 'B';
--Senior secured first lien revolver at 'BB/RR1';
--Senior unsecured notes at 'B/RR4'.
The Rating Outlook is Stable.