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07 Oct 2004
MOODY'S AFFIRMS DEVON ENERGY'S LONG-TERM DEBT RATINGS (SR. UNSECURED Baa2); RAISES OUTLOOK TO STABLE
Approximately $7.6 Billion of Debt Securities Affected
New York, October 07, 2004 -- Moody's Investors Service affirmed the long-term debt ratings of
Devon Energy Corporation (Devon, Baa2 senior unsecured) and raised
the rating outlook to stable from negative.
The change in Devon's outlook reflects progress the company has
made in several areas discussed in our credit opinion dated June 3,
2004, including (i) reduced leverage through debt repayment and
cash accumulation for future debt retirement; (ii) improved clarity
around organic reserves replacement that should more than replace 2004
production; and (iii) lower full-cycle costs, with 2004
drillbit finding and development costs expected to be roughly half of
2003 values. The stable outlook also considers Moody's expectation
that Devon will prudently manage its announced asset sale and stock repurchase
plan in the current robust commodity price environment, such that
excess cash would be returned to shareholders only after appropriate capital
investments to replace production and after targeted debt repayment.
Devon's leverage, as measured by adjusted debt per proved
developed barrel of oil equivalent (debt/PD Boe), was $5.81
at yearend 2003 (before any allocation to Devon's midstream gas
business), which is quite high for the Baa2 rating category.
Thus far in 2004, Devon has reduced debt by almost $1 billion
through both normal debt maturities and repaying bank debt, leading
to leverage of $5.15 at June 30, 2004. The
company has built up its cash balances to be able to repay $1.6
billion of debt coming due in 2005 and 2006. Devon expects to have
an additional $400 million of cash by yearend 2004 to cover a like
amount of debt maturing in 2007. Netting this cash against balance
sheet debt would drop Devon's debt/PD Boe to about $3.80,
which is more in line with the Baa2 rating. In addition,
Devon has a substantial midstream gas business that potentially supports
some of the overall company's debt. Offsetting these is the
announced asset sale that is expected to reduce reserves by about 150
MMBoe, which would raise leverage on the order of $0.50
per Boe. Moody's stable outlook is based on Devon maintaining
cash balances that offset its upcoming debt maturities through 2007,
implying net debt/PD Boe in the $4 range (before allocation to
Devon's midstream gas business), and continued durable cash
flow from the midstream gas sector.
Devon has announced its intention to repurchase up to 10% of its
common stock or about 25 million shares over the next 18 months.
At $70 per share, the total cost would be $1.75
billion, with approximately two-thirds of this amount funded
with proceeds from the announced asset sale and the remainder funded from
free cash flow. Taken together, the property divestiture
and the stock buyback reduce the size of the company and increase leverage,
which is not favorable to debt holders. However, the larger
portfolio management view is that the property sale will lead to an overdue
improvement in Devon's fundamental cost structure, which would
be credit positive. In addition, we believe that management
is committed to capital discipline, which we take to mean that Devon
will generate free cash flow in excess of capex, and to the debt
reduction targets discussed earlier. In this context, cash
flow would only be available to return to shareholders after prudent investment
in the business necessary to economically grow reserves and production
and after appropriate cash is set aside to ensure debt repayment.
In the event of a material reduction from current commodity prices,
we would expect Devon to suspend its stock repurchases.
Devon has been a classic acquire and exploit E&P company, having
made five major corporate acquisitions since 1999. Devon has shifted
its strategy this year toward a more balanced reserves replacement model
with primary emphasis on organic reserves additions. Devon is challenged
to demonstrate that it is able to replace production through the drillbit
as it has an inconsistent record historically in this area. For
example, Devon replaced just 83% of its production in 2003
and 76% in 2002 through extensions and discoveries and these percentages
are lower when revisions are included. Devon recently announced
that it expects to replace in excess of 100% of its 2004 production
and at least 150% of its 2005 production (net of asset sales).
While this remains to be seen quantitatively, there is reasonable
visibility around these estimates in terms of Devon's activity in
the Barnett Shale, Canada, GOM, and West Africa.
The corollary to reserves replacement is organic production growth.
We expect Devon's production to be up slightly in 2004 compared
to full-year 2003 (including Ocean). Production is expected
to be flat in 2005, net of property divestitures having daily production
of 90-100 MBoe, and production is further expected to be
flat to slightly up in 2006 and 2007. Moody's stable outlook
reflects these organic reserves replacement and production growth projections
in the near term.
Devon's all-sources finding and development costs (F&D)
were $8.97 per Boe for the three years ending in 2003 and
its all-sources F&D in 2003 was $10.55.
However, the company's drilling-only (excluding revisions)
F&D in 2003 was $18.76, up from $14.96
in 2002 but down from 2001's $20.81. Even with
2004 commodity prices, this level of organic capital productivity
is unsustainable and is inconsistent with Devon's Baa2 rating.
As discussed earlier, Devon expects improved reserves replacement
efficiency in 2004 and 2005 and has indicated it is exercising greater
capital discipline. This combination leads the company to expect
2004 all-sources F&D to range from $9 to $11,
or approximately half of 2003's drilling-only F&D,
and to drop further to $7 to $9.50 in 2005.
Moody's stable outlook considers that Devon's 2004 F&D
will be in the very low double digits and move into single digits in 2005.
Moody's stable outlook further reflects our sense that Devon will
continue to actively manage its E&P portfolio, which will be
reflected in several other metrics. The recent asset divestiture
announcement should lead to improved unit operating economics, including
lower LOE/Boe and downward trending G&A/Boe. This, in
conjunction with lower F&D costs, will lead to an improved leveraged
full-cycle ratio moving toward 2.5x. Devon has also
indicated that its upcoming property disposals will lengthen its reserve
life by about one year. While it is reasonable to expect that most
of the reserves to be sold will be proved developed reserves, we
anticipate that Devon will manage its reserves to keep the percentage
of proved undeveloped reserves at less than 30%, up somewhat
from the yearend 2003 value of 24%.
Devon's Baa2 rating reflects the scale and diversity of its predominantly
North American asset base, the company's improved portfolio
management that should lead to better operating performance and the benefits
of its midstream gas business in key producing basins. The rating
further considers Devon's relatively high financial leverage,
the company's need to demonstrate organic reserves and production
growth, and its high full-cycle costs, particularly
F&D costs. Devon's rating outlook could move to positive
over the medium term through a combination of consistent organic reserves
replacement in excess of 100% of production, leverage in
the $3 per Boe range and an improved full-cycle cost structure,
including drilling F&D in the single digits. Devon's
rating outlook could return to negative if its cash position falls below
levels needed to repay debt maturities in 2005-07, its net
leverage rises much above $4 per Boe, the company is unable
to replace its reserves or its cost structure deteriorates materially
from expected levels.
Ratings affected include those of Devon Energy Corporation and all of
its rated subsidiaries.
Devon Energy Corporation, headquartered in Oklahoma City,
Oklahoma, is one of the largest independent exploration and production
companies in North America.
Corporate Finance Group
Moody's Investors Service
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
No Related Data.
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