Fitch Ratings Services recently affirmed the Issuer Default Rating (“IDR”) of Newfield Exploration Company (NFX) at 'BB+' along with senior subordinated notes at 'BB,' signifying a low-to-moderate risk level. The outlook on the company that is undergoing transition was kept stable by the rating agency.
Fitch’s move on Newfield comes in the wake of the independent energy company’s steady move towards liquids and steps taken to divest international assets for a deeper domestic focus. In the near term, however, this would entail lower contribution from both natural gas and international assets. The company is moving ahead with its plans to divest its remaining offshore assets in Malaysia and China, which accounted for 6% of proved reserves at year-end 2012.
Additionally, Newfield’s leveraged balance sheet and negative free cash flow influenced the cautious rating on the company.
Newfield Exploration’s diversified portfolio of assets provides both flexibility and significant growth potential. We expect the company’s reserve potential in the Uinta, the Cana Woodford, the Williston and the Eagle Ford plays to be liquid-rich catalysts for the stock over the longer run.
Newfield remains committed to building its revenue base on oil and NGL assets and generate at least 60% year-over-year growth from their production during the first half of the ongoing fiscal year. This, we feel is attainable, as the company’s liquids production increased 30% in the first quarter on an annualized basis after adjusting the impact of asset sales.
However, we share Fitch’s skepticism related to Newfield’s relatively debt-heavy balance sheet. At the end of the recently reported first quarter, Newfield had a cash balance of $44 million and long-term debt of $3.05 billion, representing a debt-to-capitalization ratio of 52.3%.
The picture nevertheless becomes sunnier for Newfield with full availability of its $1.25 billion senior unsecured credit facility. The leveraged balance sheet also has $1.75 billion in senior unsecured notes and $1.3 billion in senior subordinated notes outstanding, with no near-term maturity.
In 2012, the independent energy company reported a negative free cash flow of $663 million. The rating agency expects the trend to continue with the company having approximately $800 million of negative free cash flow in 2013. Like in the past, the rating agency feels that the imbalance with once again be plugged by a combination of credit facility borrowings and offshore asset divestment.
We, however, feel using leverage is a smart move on the part of the company which was recently hurt by lower gas volumes. In the first quarter, Newfield’s bottom line cascaded by half from the prior-year quarter owing to its tilt towards liquids. The company also missed the recent boom time in gas realizations and saw gas volumes falling 23.3% year over year.
In order to avoid diluting the quantum of its outstanding shares, the company is prudently focusing on stemming a fall in its shareholder value over the longer run. This is amply reflected in the Zacks Consensus Estimate for earnings per share which is slated to fall to $1.47 in 2013 from $2.41 reported in 2012 given the ongoing transition phase and gas boom time. However, the estimates are expected to recover to $2.27 and $3.05 in 2014 and 2015, respectively, supported by liquids production growth in key basins.
Though we remain positive on Newfield Exploration’s emerging resource plays’ development program, we believe that its sensitivity to gas price volatility, as well as drilling results, costs, geo-political risks and project timing delays will weigh on the stock. Increasing cost pressure in the highly competitive shale plays is also a cause for concern.
Newfield Exploration shares currently retain a Zacks Rank #3, which translates into a short-term Hold rating. But there are other stocks among the domestic exploration and production players that appear more attractive in the near term. These include Abraxas Petroleum Corp. (AXAS), EPL Oil & Gas, Inc. (EPL) and Sandridge Mississippian Trust II (SDR). All the three stocks currently hold a Zacks Rank #1 (Strong Buy).
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