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27 Sep 2004
MOODY'S DOWNGRADES ENERGEN CORP.'S DEBT RATINGS (TO Baa2 SR. UNS.) AND CONFIRMS ALABAMA GAS CO.'S (A1 SR. UNS.), BOTH WITH STABLE OUTLOOKS
Approximately $560 Million of Debt Securities Affected
New York, September 27, 2004 -- Moody's Investors Service downgraded the debt ratings of Energen
Corporation (Holdco) to Baa2 senior unsecured/(P)Baa2 senior unsecured
shelf from Baa1/(P)Baa1 and confirmed those of its utility subsidiary
Alabama Gas Company (Alagasco, the utility) at A1 senior unsecured.
Energen's ratings are downgraded to reflect greater exposure to
E&P activities, notably the mounting execution risk in continuing
to grow its E&P business so as to meet its stated long-term
earnings growth targets. The confirmation of Alagasco's ratings
at a rating level four notches above Energen's reflect our view
that the utility's credit profile remains unaffected by its parent
or Energen Resources (Resources, Energen's E&P subsidiary),
and that there is a measure of protection provided by regulatory oversight.
The rating outlook is stable for both entities, acknowledging management's
financially conservative and steadfast approach to its business model
and a proven track record in its "acquire & exploit" E&P
strategy. These rating actions end a rating review prompted by
Energen's recent debt-financed $263 million acquisition
of natural gas reserves in the San Juan Basin by Resources and a re-assessment
of Alagasco's relationship with Energen and Resources.
These rating actions tie Energen's rating more closely to the business
risk profile of Resources' E&P business -- less
to that of Alagasco -- and better reflect Energen's role as
the financing vehicle for Resources. Resources has steadily developed
over time to comprise roughly 70% of Energen's capitalization,
earnings, and cash flow. Given the critical mass that it
has accrued, Resources faces a rising hurdle in continuing to grow
at a pace that will enable Energen to meet its target average EPS growth
of 7-8% a year. Given the natural declines in its
existing reserve base, Resources will be challenged to make periodic
sizable acquisitions. This execution risk is magnified by higher
than historical capital outlays that Resources would need to make amidst
rising reserve acquisition multiples, which reflect high commodity
prices and declining production in mature North America basins.
Indeed, in the five-year period ending 2008, Energen
budgets $1 billion of reserve acquisitions -- about the same
amount it has spent over the course of the past nine years and increasing
the level of execution risk per acquisition.
The four-notch rating differential between Energen and Alagasco
reflects the distinct financial positions that the company maintains for
each of its two sole lines of business. There is no operational
integration between the two. The fact that Alagasco is a SEC registrant
separate from Energen highlights its discrete, self-financing
nature. Alagasco enjoys no explicit ring-fencing provisions
from regulatory or financing agreements other than broad restrictions
under an Alabama state statute. Nevertheless, the requirement
for Alagasco to get regulatory approval before any financing helps to
prevent a debt-financed distribution of such a size that would
weaken Alagasco's credit quality. Moody's believes
that such a scenario is highly unlikely given Energen's conservative
management and the relative strength of Resources. Alagasco generates
little if any excess cash flow that could be swept to Holdco or to support
The stable rating outlooks anticipate Energen's continuing to execute
on its long-held "acquire & exploit" E&P strategy
with consistent results, including realizing expected levels of
incremental production from the newly-acquired San Juan properties
over the next two years. In addition, we assume that Energen
maintains its conservative financial policies. The outlook incorporates
periodic gas reserve acquisitions to the extent that they are in keeping
with Energen's well-articulated five-year plan,
acquisition criteria, and financial policies. The ratings
anticipate acquisitions of a size that more than offset natural declines
in Resources' existing reserves so as to manage Energen's
business mix at near current levels over time (assets and earnings derived
from E&P no higher than in the 70% range; the balance
from Alagasco), while maintaining F&D costs at around its current
historic levels and continuing its record of organic reserve replacement.
A rating downgrade could result if an acquisition veers significantly
from the company's long-held parameters (e.g.,
long-lived North American onshore gas reserves with exploitation
potential, expected production mostly hedged), is unduly debt-financed,
or produces results significantly below expectations.
Energen's asset mix and business and financial model make a rating
upgrade unlikely in the foreseeable future. Financial performance
that varies significantly from our expectations will cause us to reassess
Energen's ratings. Among those financial measures that we
will monitor include, on a consolidated basis: adequate financial
flexibility as measured by the ability to generate free cash flow after
production replacement, earnings retention (dividend payouts expected
in the 20% range), and capitalization (debt ratio expected
in the 40% range). At Resources, key indicators include:
full-cycle costs in the high teens/boe, drillbit F&D
costs in the $5/boe range, and debt burden on proven developed
reserves in the $2/boe range. For Alagasco, key metrics
include: retained cash flow/debt at around 20%, dividend
payouts in the 70% range, and debt/capital in the 40%
For Alagasco, we expect continued consistent results to be derived
from the Rate Stabilization and Equalization mechanism (RSE, a self-adjusting
rate formula which is in place at least through 1/1/08), weather
normalization, a supportive regulatory environment, and a
management committed to maintaining Alagasco's capital structure
in line with allowed levels under the RSE (ROE a band of 13.15%
to 13.65%, 60% equity/capital cap).
These underpinnings should result in gradual, small increases in
earnings over time from normal additions to rate base. We do not
expect external growth at Alagasco. Given Alagasco's stability,
any change in its rating could be a result of a currently unanticipated
change in its regulatory framework or Energen's financing model
that exposes Alagasco's credit more to those of Energen and Resources.
ANALYSIS OF RESOURCES' OPERATIONS
Over the past nine years since Energen initiated its E&P growth strategy,
Resources' reserves have steadily grown 15-fold to roughly
230 million boe, solidifying its position among independent U.S.
oil and gas producers. From its beginnings as a Black Warrior Basin
coal bed methane Section 29 play in Energen's home base of Alabama,
Resources has cumulated a credible operating track record and a more diversified
portfolio of conventional and coal bed methane reserves in the San Juan
Basin (56% of reserves, pro forma the latest acquisition),
the Permian Basin (23%), the Black Warrior Basin (16%),
and North Louisiana/East Texas (5%). Its reserves are durable:
mostly proven developed (about 80%) with an above-average
reserve life (proven developed R/P of 13 years).
Resources has increased its reserves steadily through acquisitions every
other year or so to offset natural declines of about 8% a year,
supplemented by internal additions from exploiting its existing non-producing
and undeveloped reserves. It engages in nominal exploration activity.
Resources' operating metrics are solid. The company has been
successful in maintaining better than average reserve replacement and
F&D costs (all-sources F&D costs of just under $5/boe)
while improving cash-on-cash returns (leveraged full-cycle
ratios recently in the 300% range). Resources has been conservatively
financed ($2/boe of proven developed reserves and about $2
interest/boe produced). It continually hedges the majority of its
expected production (over 80% of production hedged for the rest
of 2004, about 60% hedged currently for 2005) in order to
ensure meeting its earnings targets (7-8% average annual
eps growth) and continuing its record of modest annual dividend increases.
In August, Energen paid $263 million to purchase 40 mmboe
of San Juan reserves, half of which are behind pipe and undeveloped.
In addition, it expects to spend $50 million in developing
these properties. The consideration paid is about $102,800/boe
current daily production, $122,400/boe based on all-in
for future development costs. The full valuation reflects Energen's
expectation of doubling production from these properties over the next
two years and desire to intensify acreage in a core area. The valuation
and 100% debt financing entailed in this acquisition place an onus
on the company to realize expected incremental production over this time
frame. This concern is mitigated by Resources' familiarity
of the area (it has seven years of experience in the San Juan Basin,
including acreage nearby), long experience in coal bed methane (mostly
in the Black Warrior, and more recently the Fruitland coal in the
San Juan where the new reserves are located) and approvals in hand to
down-space locations in the acquired properties.
Headquartered in Birmingham, Alabama, Energen Corporation
is a holding company whose subsidiaries engage in natural gas and crude
oil production and natural gas distribution.
Corporate Finance Group
Moody's Investors Service
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
No Related Data.
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