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

DBRS Limited (DBRS Morningstar) downgraded Husky Energy Inc.’s (Husky or the Company) Issuer Rating and Senior Unsecured Notes and Debentures rating to BBB from BBB (high) following the close of the previously announced combination with Cenovus Energy Inc. (Cenovus; rated BBB with a Stable trend). DBRS Morningstar also downgraded Husky’s Preferred Shares – Cumulative rating to Pfd-3 from Pfd-3 (high) and its Commercial Paper rating to R-2 (middle) from R-2 (high). All trends are Stable. The actions remove the ratings from Under Review with Negative Implications where they were placed on October 25, 2020, when the combination was announced. DBRS Morningstar discontinued its rating on the Company’s Preferred Shares as the Husky preferred shares have been exchanged for Cenovus preferred shares as part of the combination. DBRS Morningstar has also discontinued and withdrawn its rating on Husky’s Commercial Paper at the request of the Company. 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. DBRS Morningstar’s expects the amalgamation to be completed as planned. Consequently, DBRS Morningstar’s ratings for Husky are consistent with the Issuer Rating of Cenovus. Once the amalgamation is completed, the Issuer Rating for Husky will be discontinued and the Senior Unsecured Notes and Debentures will be rated as Cenovus’ Senior Unsecured Debt.

DBRS Morningstar assessed the consolidated business risk profile of the combined entity to be moderately stronger relative to Husky’s stand-alone business risk profile. However, the rating downgrades reflect DBRS Morningstar’s opinion that the impact of the stronger business risk profile is more than offset by weakness in the combined entity’s consolidated financial risk profile, relative to Husky’s stand-alone financial risk profile, because of a material increase in indebtedness and resulting weaker financial metrics (see DBRS Morningstar’s press release “DBRS Morningstar Places Husky Energy Inc. Under Review–Negative Following Agreement to Combine with Cenovus Energy Inc.,” dated October 25, 2020).

Cenovus, as the resulting combined entity, plans 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. 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 a 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 combined with 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), 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 2, 2020), 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 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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