DBRS Morningstar Upgrades Cenovus Energy Inc. Following the Close of the Combination with Husky Energy Inc.; Removes Under Review with Positive Implications Status

DBRS Limited (DBRS Morningstar) upgraded Cenovus Energy Inc.’s (Cenovus or the Company) Issuer Rating and Senior Unsecured Debt rating to BBB from BBB (low) following the close of the previously announced combination with Husky Energy Inc. (Husky; rated BBB with a Stable trend). All trends are Stable. The actions remove the ratings from Under Review with Positive Implications where they were placed on October 25, 2020, when the combination was announced. DBRS Morningstar also assigned a rating of Pfd-3 with a Stable trend to the Preferred Shares – Cumulative issued by Cenovus as part of the combination. Post-closing, Husky is a wholly owned subsidiary of Cenovus. Both entities are to be amalgamated, after which Cenovus will continue as the surviving entity and become the obligor under Husky’s existing long-term notes and other direct obligations.

The rating upgrade is driven by a material improvement in Cenovus’ business risk profile and a modest improvement in its financial risk profile as a result of the combination (see DBRS Morningstar’s press release “DBRS Morningstar Places Cenovus Energy Inc. Under Review–Positive Following Agreement to Combine with Husky Energy Inc.,” dated October 25, 2020). The improvement in the Company’s business risk profile is underpinned by an increase in size, diversification, and improved capital flexibility. The combination tempers Cenovus’ sensitivity to Western Canadian price differentials through access to additional heavy oil processing, storage, and pipeline transportation capacity. Cenovus is also expected to benefit from Husky’s production in Asia-Pacific, which currently generates approximately $1.0 billion in annual free funds flow predominantly under fixed-price natural gas sales contracts. The factors tempering the business risk profile improvement include the combined entity’s high percentage of pro forma production from Western Canada, a reserve base geared more toward heavy and thermal oil (89% of total pro forma proved reserves at YE2019), and rising environmental cost pressures.

DBRS Morningstar expects that Cenovus’ financial risk profile over the forecast period through to 2022 to be modestly stronger as a result of the combination despite an increase in total debt (the pro forma lease-adjusted debt at September 30, 2020, was $17.9 billion). As the combined entity, DBRS Morningstar expects Cenovus to pursue a conservative financial policy and prioritize deleveraging the balance sheet over the medium term. A sizable free cash flow (FCF; cash flow after capital expenditures and dividends) surplus is expected by 2022 as earnings and operating cash flow increase based on the assumption of recovering crude oil prices, improved refining margins, and the realization of expected synergies from the combination (approximately $1.2 billion in total expected annually with $900 million targeted in the first year). DBRS Morningstar expects key credit metrics using its base-case commodity price assumptions to remain relatively weak in 2021 before materially improving in 2022 (lease-adjusted debt-to-cash flow around 2.5 times). DBRS Morningstar expects Cenovus to maintain its strong liquidity position.

DBRS Morningstar maintains a longer term midcycle pricing forecast range of USD 50 to USD 60 per barrel (/bbl) for West Texas Intermediate (WTI) crude oil. DBRS Morningstar expects that the lower end of the midcycle price range (USD 50/bbl for WTI crude oil) to be reached by 2022 aided by successful deployment of the Coronavirus Disease (COVID-19) vaccine and continued production containment efforts by OPEC+. Accordingly, in assessing the credit risk profiles of issuers, DBRS Morningstar’s approach is to rate through the price cycle and give due weight to projected credit metrics as market conditions are anticipated to normalize by 2022. The Stable trends reflect DBRS Morningstar’s expectation that Cenovus’ financial risk profile will improve by 2022 to a level commensurate with the rating. The Stable trends also reflect the recent improvement in crude oil prices which have trended well above DBRS Morningstar’s base-case WTI benchmark price assumptions in 2021 of USD 40/bbl. DBRS Morningstar expects Cenovus to be able to deleverage meaningfully over the medium term even in a WTI price environment of USD 45/bbl.

Given DBRS Morningstar’s current commodity price assumptions, a rating upgrade is unlikely over the next two years. However, a negative rating action may result if the projected improvement in credit metrics does not materialize because of weaker-than-expected crude oil prices and refining margins and/or the combined entity is unable to realize the projected synergies as planned.

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.

Notes:
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 17, 2020), DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2, 2020), and DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 2, 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 info@dbrsmorningstar.com.

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.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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