DBRS Limited (DBRS Morningstar) downgraded Husky Energy Inc.’s (Husky or the Company) Issuer Rating and Senior Unsecured Notes and Debentures rating to BBB (high) from A (low), its Commercial Paper rating to R-2 (high) from R-1 (low), and its Preferred Shares – Cumulative rating to Pfd-3 (high) from Pfd-2 (low). All trends are Negative. DBRS Morningstar also removed the ratings from Under Review with Negative Implications, where they were placed on March 26, 2020.
DBRS Morningstar placed the ratings Under Review with Negative Implications in response to the extreme price declines and heightened volatility in crude oil markets largely caused by the rapid spread of the Coronavirus Disease (COVID-19) and the concurrent crude oil-price war between OPEC (led by Saudi Arabia) and Russia. Subsequently, DBRS Morningstar revised its commodity price assumptions to factor in (1) the impact of the coronavirus pandemic on crude oil demand as lockdowns ease, (2) the significant buildup in global oil inventories, and (3) the impact of production cuts recently implemented by OPEC+. The downgrade follows DBRS Morningstar’s expectation that the Company’s key credit metrics will remain below the threshold for an A (low) rating over the next three years under the revised commodity price assumptions (see DBRS Morningstar’s May 15, 2020, commentary titled “As Coronavirus Lockdowns Ease, DBRS Morningstar Resets Outlook for Oil and Natural Gas Prices”).
Under normal circumstances, Husky’s downstream refining assets provide a buffer against lower crude oil prices; however, the coronavirus has caused a simultaneous and steep decline in demand for crude oil and refined products. Consequently, DBRS Morningstar expects earnings at the Company’s upstream and downstream segments to be materially weaker in 2020 relative to 2019. In response to the current downturn, Husky has reduced its budgeted capital expenditures (capex) by 50% in 2020 to between $1.6 billion and $1.8 billion; reduced its common dividend payments by 90%; curtailed lower-margin production; and initiated cost-reduction measures. Despite these measures, DBRS Morningstar expects the Company to generate a material free cash flow (FCF; cash flow after capex and dividends) deficit in 2020 under its base-case Western Texas Intermediate and Brent price assumption of USD 32 per barrel (/bbl) and USD 37/bbl, respectively. Husky will likely fund the FCF deficit primarily from available cash balances ($1.3 billion at March 31, 2020). DBRS Morningstar anticipates that, as coronavirus lockdowns ease, demand and margins in the downstream segment will recover faster and stronger relative to the upstream segment. Based on DBRS Morningstar’s price forecasts, it expects the Company to generate a modest FCF surplus in 2021, which should increase materially in 2022 as Husky benefits from higher commodity prices, lower capex, and reduced dividend payments. DBRS Morningstar forecasts that gross debt levels will remain relatively flat, but also expects key credit metrics under its base-case commodity price assumptions to remain weak in 2020 and 2021 before improving in 2022 (lease-adjusted debt-to-cash flow at or around 2.0 times) as earnings and operating cash flow increase because of higher commodity price assumptions and the Company uses FCF surplus to reduce debt. However, the improvement in credit metrics is not sufficient to support the previous A (low) rating, leading to a downgrade.
The Company’s size, highly integrated heavy and thermal oil business, capital flexibility, and portfolio of lower-cost growth opportunities underpin its business risk profile, which supports the BBB (high) rating. Factors tempering the ratings include the Company’s higher percentage of production from Western Canada, relatively shorter proved developed reserve life, and a reserve base geared more toward heavy and thermal oil (69% of total proved reserves at YE2019). The majority equity stake held effectively by Mr. Li Ka-shing’s family trust and indirectly by CK Hutchinson Holdings Limited, which has been important in the implementation of Husky’s growth plans, also supports the ratings.
DBRS Morningstar notes that Husky has maintained a relatively conservative financial profile relative to most of its domestic peers. The Company has built up a sizable cash balance that should allow it to navigate the current downturn without a material increase in gross debt, but the improvement in key credit metrics is predicated on higher crude oil prices and improved refining margins. DBRS Morningstar’s approach is to rate through the cycle and give due weight to projected credit metrics when it anticipates a return to more normalized market conditions; however, the outlook for demand remains fluid and there is a risk that the recovery in commodity prices may fall short of DBRS Morningstar’s base-case price assumptions and Husky's overall financial risk profile will not support the current ratings. The Negative trends reflect this risk, which DBRS Morningstar assesses to be elevated.
DBRS Morningstar believes that the Company has sufficient liquidity to navigate the current downturn. Husky’s committed credit facilities consist of two tranches: $2.0 billion maturing in June 2022 and $2.0 billion maturing in March 2024. As at March 31, 2020, the Company had $3.0 billion available under its committed credit facilities and $1.3 billion in available cash balances. In April 2020, the Company also availed a $500.0 million committed credit facility with a two-year term. Husky’s long-term debt maturities over the next three years are reasonable with USD 500 million maturing in 2022. DBRS Morningstar expects the Company to repay the maturities primarily from FCF surplus under DBRS Morningstar’s base-case price assumptions. DBRS Morningstar also expects Husky to remain in compliance with the applicable covenant on the credit facilities, including debt-to-capitalization of less than 65%, even if commodity prices trend lower than expected.
DBRS Morningstar may change the trend to Stable if the demand/supply dynamics in the crude oil markets continue to improve, leading to greater confidence that commodity prices and, consequently, the Company’s key credit metrics improve in line with DBRS Morningstar’s base-case assumptions. Conversely, DBRS Morningstar may take a negative rating action if commodity prices and key credit metrics fall below DBRS Morningstar’s expectations.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Rating Companies in the Oil and Gas and Oilfield Services Industries (August 23, 2019); DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019); DBRS Morningstar Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (March 10, 2020); DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 1, 2019); and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 22, 2020), which can be found on dbrsmorningstar.com under Methodologies & Criteria.
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at firstname.lastname@example.org.
The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.
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