MOODY'S ASSIGNS B2 TO ENERGY PARTNERS' SENIOR UNSECURED NOTES
Approximately $150 Million of Debt Securities Affected
New York, July 21, 2003 -- Moody's assigned first time ratings for Energy Partners, Ltd.
(EPL). Rating support: strong pro-forma liquidity,
a still-supportive price environment, moderate net debt on
proven developed (PD) reserves, seasoned management, and acceptable
risk balance in its drilling program relative to cash flow and capital.
Ratings restraint: small total reserves; particularly small
proven developed producing (PDP) reserves; credit implications of
a particularly short PDP reserve life and short 4.6 year PD reserve
life; high leveraged full-cycle unit costs; 52%
of production concentrated in the East Bay Field (though repeatability
is aided by roughly 30 of EPL's 80-plus prospects being located
in East Bay); heavy capital needs; and acquisition risk with
attendant due diligence and overpayment risk.
With a stable rating outlook, Moody's:
(1) Assigned a B2 rating to EPL's proposed $150 million of
seven year senior unsecured guaranteed notes.
(2) Assigned a B2 Senior Implied Rating.
(3) Assigned a B3 Senior Unsecured Issuer Rating.
To solidify the ratings and retain a stable outlook, EPL will need
to reinvest cash flow and balance sheet cash with sufficient productivity
to consistently grow PD reserves relative to debt, production relative
to preferred dividends and interest expense, positive sequential
quarter production trends, and acceptable combined total of unit
operating, G&A, interest, and reserve replacement
The ratings are supported by: modest pro-forma net leverage,
aided by a 2003 $74 million equity offering ($38 million
net); good liquidity to backstop the drilling and development program,
with roughly $65 million of pro-forma cash and an undrawn
$60 million secured borrowing base revolver maturing 2005;
numerous drilling prospects in productive, though very mature,
regions; seasoned management with long-experience in the shallow
waters of the Gulf of Mexico (GOM) and intending to avoid excessive leverage;
and up-cycle hedging of 50% of second-half 2003 (though
a low 10% of 2004 production). EPL intends to add 2004 hedging
during the remainder of 2003.
While EPL currently generates fairly wide cash flow cover of operating,
funding, and reserve replacement costs (RRC), this is during
high up-cycle oil and natural gas prices. Prices are inherently
volatile and likely to run at lower average prices through 2004.
The ratings are restrained by: EPL's small total proven reserve
scale; particularly small PDP reserves, the generator of all
cash flow; a particularly short PDP reserve life on annualized first
quarter production, with attendant heavy reserve replacement capital
outlays and risk; a short 4.6 year PD reserve life; heavy
required capital needs for EPL's particularly high combined proportion
of proven developed non-producing (PDNP) and proven undeveloped
(PUD) reserves; concentration of 52% of production in its
very mature East Bay complex in the eastern Louisiana GOM, and acquisition
EPL's size, diversification profile, and short PDP and
PD reserve lives make it vulnerable to inherent drilling and production
disappointments. It also must fund very heavy capital needs,
and absorb attendant drilling, initial production, and decline
curve risk, to develop and produce its large proportion of PDNP
and PUD reserves. Once brought to production, Moody's
expects those reserves to also have relatively short volumetric half-lives.
EPL also faces heavy plugging and abandonment capital needs for its high
proportion of very mature properties.
The stable outlook would be vulnerable to poor sequential quarter production
trends, rising debt without a proportional production response,
and/or significantly rising interest expense per unit of production.
EPL's acquisition and capital programs substantially outspent cash
flow each year of its existence. Production rose 11% from
first quarter 2002 to mid-2003, with declines in second half
2002 largely due to shut-in from tropical storm activity.
Additionally, while the note rating is not notched below the B2
senior implied rating due significant cash balances and no borrowings
under EPL's $60 million secured revolver, the note
rating could be reduced by one notch in the future if material senior
secured debt is incurred, particularly absent an amply commensurate
increase in PD reserves and production.
Fully loaded for $221 million of forthcoming necessary development
and plugging and abandonment capital needs for already proven reserves,
and adjusted for rising GOM drilling and services costs, EPL's
all-sources RRC's are significantly higher than its reported
three-year average rate of $7.70/boe ($5.38/boe
for acquisitions and $12.49/boe from the drillbit).
For 2002, excluding follow-on drilling and development capital
needs, EPL's all-sources RRC's were a high $10.66/boe,
with reserve replacement from acquisitions costing $12.60/boe
(driven by the Hall-Houston acquisition) and reserve replacement
from the drill bit costing $8.33/boe.
Sector RRC's are very high in the GOM but, during natural
gas price up-cycles, tend to be covered by up-cycle
cash flows. EPL's ability to internally fund full reserve
replacement spending in weaker price environments could be difficult.
Furthermore, its short PDP reserve life and the mature nature of
its holdings restrain its capacity for internal growth.
Moody's anticipates between $145 million and $165
million of 2003 EBITDAX, annualized pro-form interest expense
and preferred dividends of roughly $16 million to $17 million,
and approximately $110 million of capital spending. Based
on EPL's reported $7.70/boe three year average reserve
replacement costs, Moody's calculates EPL's leveraged
full-cycle costs to be approximately $19/boe to $20/boe,
consisting of $6/boe of production costs, a high $3.25/boe
to $3.50/boe of annualized G&A costs, interest
and preferred dividends in the range of @2.30/boe, and the
$7.70/boe of RRC's. Moody's expects EPL's
2003 RRC's to meaningfully exceed its three year level.
For second quarter 2003, Moody's estimates that EPL realized
$29.45/boe of revenue covering full-cycle costs by
roughly 150%. However, higher reserve replacement
costs and expected less robust 2004 oil and gas prices could readily reduce
that cushion. Second quarter results indicate pro-forma
EBITDAX/Gross Interest coverage to be in the range of 8 times.
The balance sheet includes $38 million of FAS 143 dismantlement
provisions (reserve for plugging and abandonment costs) and the footnotes
display $17.5 million of operating leases. Excluding
those items, total effective debt would include the $150
million of notes and $35 million of convertible preferred stock.
Book equity was $156 million. Back-up liquidity would
consist of approximately $67 million of cash, the undrawn
$60 million revolver,
The preferred stock conversion price is $8.54 a share in
January 2005 and EPL's common was trading at roughly $10.50/share
today. However, largely for tax planning purposes,
the preferred stock is also exchangeable at EPL's option,
at any time, into notes due January 2009 at a coupon matching the
7% dividend yield.
Pro-forma gross leverage on reserves is high though net debt leverage
is more moderate. Pro-forma gross debt divided by PD reserves
would be $4.58/boe excluding preferred stock and $5.65/boe
including the preferred. However, pro-forma net debt
on PD reserves would be a much lower $2.60/boe excluding
preferred stock and $3.66/boe including the preferred.
Gross debt divided by PDP reserves is far higher than the Debt/PD figure.
Importantly, gross debt plus $221 million of third party
engineered development and plugging and abandonment capital outlays needed
for current proven reserves is a very high $7.81/boe ($6.55/boe
using net debt) and $8.89/boe including preferred stock
Energy Partners, Ltd. is headquartered in New Orleans,
Louisiana, focusing in the shallow waters of the Gulf of Mexico,
acquiring drilling acreage and mature properties to principally exploit
traditional shallow to mid-depth drilling horizons. The
company allocates a portion of exploration capital to higher risk higher
impact deep horizons under shallow Gulf waters.
Alexandra S. Parker
Senior Vice President
Corporate Finance Group
Moody's Investors Service
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service