DBRS Morningstar Downgrades Ratings of Cenovus Energy Inc. to BBB (low), Negative; Removes Under Review with Negative Implications Status

DBRS Limited (DBRS Morningstar) downgraded Cenovus Energy Inc.’s (Cenovus or the Company) Issuer Rating and Senior Unsecured Debt rating to BBB (low) from BBB and removed the ratings from Under Review with Negative Implications, where they were placed on March 26, 2020. Both trends are Negative. On March 26, 2020, DBRS Morningstar placed Cenovus’s 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 a BBB 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”). The Negative trend reflects the dependence of the key credit metrics on higher commodity prices, especially in 2022 to support the current rating.

Cenovus’s cash flow/earnings are highly sensitive to the Western Canadian heavy-light oil-price differential and changes on the price of WTI. DBRS Morningstar expects the Company’s key credit metrics to deteriorate well below the BBB range, especially in 2020, due to the sudden and severe decline in crude oil prices and refining margins. In response, the Company has reduced its budgeted capex by 43% in 2020 to between $750 million and $850 million; suspended its dividend payments; actively managed production levels; suspended its crude-by-rail program; and initiated cost-reduction measures, which the Company expects to yield cash savings of $150 million in 2020. As a result, the Company expects its FCF breakeven at a WTI price of USD 38/bbl, assuming a WTI to Western Canadian Select (WCS) differential of USD 12.50/bbl. Despite these defensive measures, DBRS Morningstar expects the Company to generate a material free cash flow (FCF; cash flow after capex and dividends) deficit (in excess of $1.0 billion) in 2020 under its base case WTI price assumption of $32/bbl and a WTI to WCS differential of USD 12/bbl. DBRS Morningstar notes that current WTI and WCS prices are tracking ahead of DBRS Morningstar’s base case forecast for 2020, which, if sustained could result in a lower FCF deficit and lower debt levels in 2020. The FCF deficit is likely to be funded by drawing on available liquidity. Based on DBRS Morningstar’s price forecasts the Company is expected to generate a FCF surplus in 2021, which should increase materially in 2022 as the Company benefits from higher commodity prices, a lower cost structure, and the suspension of dividend payments. Consequently, DBRS Morningstar expects the Company’s key credit metrics to improve in 2022 (lease-adjusted debt-to-cash flow at or around 3.5 times (x)) as the Company uses FCF surpluses to reduce debt. However, the improvement in credit metrics is not sufficient to support the previous BBB ratings, leading to a downgrade.

Cenovus’s BBB (low) rating is supported by the Company’s business risk profile, which is underpinned by (1) the Company’s sizable production base in Western Canada (483,000 barrels of oil equivalent/day in the first quarter of 2020) coupled with its joint venture (JV) interests in two U.S. mid-continent refineries (net capacity of 247,500 bbl/day); (2) long-life low-decline oil sands reserves; (3) high level of capital flexibility and highly efficient oil sands operations; and (4) downstream integration through the Company’s refining JVs, which, under normal circumstances, tempers the impact of oil-price volatility and changes in the heavy-light oil-price differential. Key challenges include the exposure to oil sands production and related heavy-light oil-price differential and lack of geographic diversification.

The Company’s long-life reserves with low base decline rates allow the Company to maintain production with relatively lower capital spending (approximately $5/bbl) compared with unconventional producers. Coupled with low operating costs ($7/bbl to $8/bbl) at its two key developments (Foster Creek and Christina Lake), DBRS Morningstar expects the Company to generate significant a FCF surplus at WTI price of USD 45/bbl and above, as demonstrated in 2019. In addition, DBRS Morningstar anticipates that, as coronavirus lockdowns ease, demand and margins in the downstream segment will recover faster and stronger relative to a recovery in the upstream segment. Cenovus has previously used FCF surpluses to deleverage the balance sheet with total debt repayments of USD 2.75 billion since Q3 2018. DBRS Morningstar expects the Company to prioritize deleveraging its balance sheet with projected FCF surpluses in 2021 and 2022. However, the outlook for demand remains fluid and the Negative trend reflects the risk that the recovery in commodity prices may fall well short of DBRS Morningstar’s base-case price assumptions..

DBRS Morningstar believes the Company has sufficient liquidity to navigate the current downturn. The Company’s committed credit facilities consist of two tranches, $3.3 billion maturing in November 2023 and $1.2 billion maturing in November 2022. As at March 31, 2020, the Company had $4.4 billion available under its committed credit facilities. In addition, in April 2020, the Company availed a $1.1 billion committed credit facility with a one-year term, which is currently undrawn. The Company also had uncommitted credit facilities of $1.6 billion, which was partially drawn or used for letters of credit at the end of Q1 2020. The Company’s long-term debt maturities are well spread out with USD 950.0 million maturing between now and 2027 (in August 2022 and September 2023). DBRS Morningstar expects the Company to repay the maturities primarily from FCF surplus under its base-case price assumptions. DBRS Morningstar also expects the Company 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, should commodity prices and key credit metrics fall below DBRS Morningstar’s expectations, a negative rating action could be taken.

ESG CONSIDERATIONS
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 23, 2019); and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019), 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.

DBRS Morningstar will publish a full report shortly that will provide addi¬tional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrsmorningstar.com.

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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