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28 Jul 2005
MOODY'S CONFIRMS THE RATINGS FOR HARVEST OPERATIONS CORP.; OUTLOOK IS STABLE
Approximately US$250 Million of Debt Securities Affected
New York, July 28, 2005 -- Moody's confirmed the B2 Corporate Family Rating (formerly the senior
implied rating) and the B3 notes rating on Harvest Operations Corp.
(HOC) US$250 million of 7-year senior unsecured notes.
The outlook is stable. The ratings confirmation completes the ratings
review commenced 6/28/05.
Moody's confirmed the ratings but will monitor the company's
ability to avoid re-leveraging given the amount of cash flow it
can generate relative to the capex and distributions expected throughout
the rest of the year. The confirmation of the existing ratings
reflects the company's issuance of C$175 million (US$140
million) of new common units along with CAD $75 million (US$60
million) of subordinated convertible debentures to fund the announced
C$260 million (US$210 million) acquisition of properties
in Northeast British Columbia. The equity and convertible debenture
offerings are expected to close in conjunction with the acquisition on
August 2, 2005. Moody's also affirmed the company's
Speculative Grade Liquidity rating of SGL-3.
Upon the announcement of the acquisition, Moody's placed Harvest's
ratings under review for possible downgrade as the company indicated that
the acquisition was to be all-debt funded, at least initially.
An all debt funded acquisition would have pushed leverage (debt/proven
developed reserves) to about C$9.07/boe (US$7.34/boe),
which would have been unsustainable for the current ratings. However,
with the subsequent equity offering, the company's leverage
will be approximately C$6.80/boe, (US $5.44/boe)
including the convertible notes offering. This level of leverage
is actually lower than the reported Q1'05 leverage of C$6.88/boe
and continues a trend of lower leverage over the past three quarters since
it levered up to C$8.11/boe in Q3'04.
The stable outlook reflects the expectation that the company will maintain
leverage below C$ 7.00/boe and that material future acquisitions
will be amply funded with equity. However, a negative outlook
and/or ratings downgrade would be considered if leverage rises above C$7.00/boe
(US $5.60/boe) given the unit distributions that need to
be made; if the company cannot mount sustainable sequential quarter
organic production gains; if capital productivity deteriorates as
measured by all-sources finding and development (F&D) costs
materially rising above the C$12.76/boe (US $10.20/boe)
reported for year-end 2004.
A positive outlook would require additional scale in its proven developed
reserve base at competitive F&D costs that results in enhanced durability
and diversification of the existing asset portfolio and is substantially
equity funded; sustainable quarterly production gains; and sustainable
leverage on the PD reserve base around C$5.00/boe.
The B2 Corporate Family Rating reflects the increased scale of the company's
reserve base with the addition of a new core area; expected improvement
in price realizations with new hedges and the higher realizations of the
new properties; improved cash flow cover of its reserve replacement
costs under still very supportive commodity prices; a high degree
of ownership (21%) by the Chairman and his demonstrated willingness
and capacity to invest new second secured funding for acquisitions;
the Chairman's prior participation in building and successfully
selling an exploration and production company.
The ratings are restrained by still full leverage; declining organic
production trends prior to the acquisition; rising total full cycle
costs; still low price realizations of its heavy oil production and
hedges put in place last year; the unit trust structure which entails
significant cash distributions to unit holders; a relatively short
proven developed (PD) reserve life; and the reliance on acquisitions
to fuel growth that is typical under the unit trust business model.
The SGL-3 rating reflects the cash flow and outlook supported by
still strong commodity prices and the additional production from the acquired
properties; significant availability under the secured revolving
credit facility and the ample room under the facility's maintenance
covenants over the next twelve months. However, the SGL-3
rating is tempered by the high amount of planned capex and unit distributions
that could utilize all projected cash flow and may even require additional
revolver funding if production levels are disappointing; the exposure
of the revolver availability to commodity price declines; and the
encumbrance of the asset base by the revolver lenders.
Moody's confirmed the following ratings for HOC:
B2 - Corporate Family Rating (formerly the senior implied rating)
B3 - $250 million 7.875% senior unsecured
notes due 2011
While the acquisition provides additional production and potential growth
opportunities, the existing property base had been showing declining
production trends. After closing the Encana acquisition in September
2004, Harvest's quarterly production has declined, with
Q1'05 seeing a 7% drop from Q4'04 and Q2'05 is
not likely to be any better. The production decline is due to the
relatively short lived properties in the core asset base and the limited
ability to complete some needed workovers in some flooded areas of Alberta.
From a cost perspective, the company's total full cycle costs
have been rising. Though still amply covered despite the wide differentials,
they have been on an increasing trend since Q1'04. For Q1'05,
total full cycle costs were C$28.72/boe (US $22.98/boe),
which consists of a high C$10.35/boe (US $8.28/boe)
for lease operating expenses, C$2.07/boe (US $1.65/boe)
for G&A expenses, and C$3.54/boe (US $2.83/boe)
of interest expense, reflecting higher debt levels. The full
cycle costs also include C$12.76/boe (US $10.18/boe)
of all sources F&D. which increased from the prior year as
2004, one-year all sources F&D rose to C$15.87/boe
from C$13.39 in 2003. With this acquisition,
Moody's expects the unit costs to be higher given the interest expense
tied to new convertible debentures, though Harvest will have the
option to issue units in place of cash interest expense on those new convertibles.
LOE is expected to also be higher in Q2'05 due to flooding in Alberta
that resulted in delayed workovers and resulted in some production outages.
Given the price paid for the acquired properties, we expect that
2005 all-sources F&D will also be higher that 2004.
The acquisition consists of 14.3 mmboe of total proved reserves
including 12.3 mmboe of proved producing reserves, and net
daily production of approximately 4,160 mboe. Based on the
$260 million announced price (before any adjustments), the
price per daily boe of production, net of royalties, is C$62,500/boe
(US$50,625/boe), and a high C$21.20/boe
(US$17.17/boe) of proved developed reserves also net of
royalties. Fully loaded for the engineered development capex to
bring the proven undeveloped reserves to the producing stage, the
purchase price is C$22.65/boe (US$18.35/boe).
The acquired properties are located in N.E. British Columbia,
and consist of sweet medium oil, and therefore has historically
had a narrower differential than most of the company's existing
oil production which should help overall realizations. The acquisition
offers the company diversification of the existing production and reserve
base, however, it is a new area and therefore could have a
bit of a learning curve before meeting management's expectations.
The notes remain one rating notch below the Corporate Family Rating due
to substantial existing and expected effective subordination to senior
secured bank debt. However, asset coverage is also cushioned
to a degree by C$85 million of subordinated debt junior to the
rated notes. We expect growth to be driven by acquisitions funded
by HTE's C$400 million of committed secured bank revolver.
The SGL-3 rating is based on Moody's expectation of Harvest's
EBITDA ranging between C$250 million and C$300 million which
combined with the secured revolver, should be sufficient to cover
C$120 million of planned capex, C$32 million of interest
expense, about C$100 million to C$150 million of unit
distributions (depending on the DRIP and Premium DRIP participation levels)
and working capital needs.
While there is expected to be ample availability under the company's
new senior secured revolver that will be in place at close of the acquisition.
Harvest will have a C$400 million borrowing base with approximately
$107 million drawn, leaving the company with ample external
liquidity. The new facility will have a one-year maturity,
and will have the same maintenance covenants, with an EBITDA/interest
minimum requirement of 3.5x. Given the earnings and cash
flow outlook over the next year, Harvest should be able to easily
meet this test. The facility will also have a working capital measurement
which will either add to or subtract from availability depending on whether
there is a working capital surplus or deficit. In addition,
the facility is secured by essentially all of the assets of the Trust,
limiting alternate sources of liquidity.
Harvest Operations Corp. is a wholly-owned subsidiary of
Harvest Energy Trust which is headquartered in Calgary, Alberta,
Corporate Finance Group
Moody's Investors Service
Asst Vice President - Analyst
Corporate Finance Group
Moody's Investors Service
No Related Data.
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