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Fitch Affirms Diamondback's Ratings at 'BBB' Post Close; Assigns 'BBB' Rating to QEP; Outlook Stable

· 03/17/2021 17:40
Fitch Affirms Diamondback's Ratings at 'BBB' Post Close; Assigns 'BBB' Rating to QEP; Outlook Stable

(The following statement was released by the rating agency)

Fitch Ratings-Chicago-17 March 2021:

Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) and unsecured ratings of Diamondback Energy, Inc., Diamondback O&G LLC and Energen Corporation (collectively Diamondback) at 'BBB' following the acquisition close. The ratings have been removed from Rating Watch Negative, and a Stable Outlook has been assigned. Fitch has also assigned an IDR and senior unsecured ratings of 'BBB' to QEP Resources, Inc. to equalize the ratings with Diamondback.

The affirmation of the ratings and Stable Outlook reflects the clearer operational and more de-risked capital allocation plan, in conjunction with a more supportive pricing environment, since the transaction announcement which should materially improve the near-term FCF profile and reduces overall execution risk for management's debt repayment plan. Fitch also believes the potential for non-core asset sales could further accelerate gross debt reduction and anticipates any cash flow will be prioritized towards gross debt repayment. The current $65+/bbl Brent oil price environment provides considerable cash flow headroom and supports the company's deleveraging capacity.


Key Rating Drivers

High-Grading, FCF Generative Assets: Fitch views Diamondback's pro forma asset profile favorably, given QEP and Guidon's adjacent acreage, which immediately compete for capital. Their sizeable proved developed producing reserves (PDP) streams also incrementally add FCF. The transactions add approximately 65 mboepd of core Permian production in 2021 and high-grades Diamondback's drilling inventory, which enhances production and capital efficiencies and should improve overall returns.

Diamondback expects to maintain its low-cost structure with LOE expenses of approximately $4.00/boe in 2021-2023, and plans on applying their co-development strategy on QEP and Guidon acreage, which Fitch believes helps optimize inventory, enhance returns, and reduces completion costs. While the acquisitions increase gross debt levels and heighten near-term forecast leverage metrics, Fitch believes the improved FCF profile at current pricing levels allows for meaningful debt repayment.

FCF Forecast, Credit-Conscious Allocation: Fitch's base case forecasts approximately $360 million, $900 million, and $1.3 billion of post-dividend FCF in 2021, assuming a Brent price environment at $40/bbl, $50/bbl and $60/bbl, respectively. Diamondback's positive FCF profile is expected to continue through relatively flat production in 2021 and low-to-mid single digit production growth thereafter.

Cash flows in 2021 are supported by Diamondback's current hedge position with approximately 65% of expected oil production hedged at an average price of approximately $44/bbl. Fitch projects the company starts to generate positive post-dividend FCF at about $35/bbl Brent and estimates that 2021 FCF improves by roughly $50 million-$75 million for each $1/bbl increase in Brent oil prices. Fitch believes debt repayment is achievable through forecast base case FCF generation, and expects the company will take a credit-conscious approach to capital allocation, prioritizing gross debt reduction.

Leveraging Transaction, Deleveraging Capacity: Fitch recognizes that the transactions are leveraging near term, but expect deleveraging in 2021 through gross debt reduction. Fitch believes the high-graded pro forma asset profile and currently supportive pricing environment combined with Diamondback's current hedge position provides support for FCF generation and gross debt repayment capacity. Fitch's base case forecasts gross debt/EBITDA of 2.4x in 2021, dropping to 1.7x in 2022 as management executes its gross debt reduction plan. The potential disposition of QEP's Williston assets would also accelerate gross debt repayment.

Supportive MLP Affiliates: Diamondback has two publicly traded MLP affiliates, 71% ownership in Rattler Midstream LP and approximately a 58% ownership in Viper Energy Partners, LP. Fitch believes both entities support Diamondback's advantaged unit economics, as Rattler has core water infrastructure assets, which reduce the company's cost structure in all seven of Diamondback's core operating areas. In addition, Diamondback's well economics are higher on Viper acreage given the advantaged net revenue interest. Fitch believes both entities provide a source of contingent liquidity.


Derivation Summary

Diamondback is among the largest Permian Basin-focused independent exploration and production (E&P) companies with a considerable, high-quality footprint within the Delaware and Midland Basins. Diamondback's pro forma fiscal 2021 production volume of approximately 370 mboepd (80% liquids) is less than Pioneer Natural Resources Co., pro forma the Parsley Energy, Inc. acquisition, (BBB+/Stable; approximately 540 mboepd), but greater than Endeavor Energy Resources, L.P. (BB+/Positive; 167 mboepd for 3Q20).

Fitch believes Diamondback's Permian Basin focus, particularly the company's considerable, contiguous positions, provides an opportunity to focus capital, optimize drilling and completion techniques to maximize returns, and provides operational flexibility in commodity price downturns. However, the limited geographic and hydrocarbon diversification can heighten asset-level risks, in the longer term.

Diamondback's standalone, unhedged half-cycle netbacks of $15.4/boe (61% margin) for 2020 was slightly below peer Pioneer ($17.9/boe; 66% margin), but consistent with the Permian peer average. In terms of leverage, Diamondback's fiscal 2021 leverage of 2.4x is higher than both Pioneer (sub-1.5x) and Endeavor (1.4x) given the leveraging transaction, but Fitch does expect leverage to improve to sub-2.0x levels in 2022 following management's debt repayment plans.

The combinations of ConocoPhillips-Concho, Pioneer-Parsley, and Devon-WPX have largely resulted in positive rating momentum due to the increase in size and scale, while maintaining sub-1.5x leverage metrics. Diamondback's transactions more modestly increase production size, while maintaining leverage in the 2x range which are both consistent with 'BBB' rating tolerances.


Key Assumptions

--WTI oil price of $55/bbl in 2021 and $50/bbl in 2022 and thereafter;

--Henry Hub natural gas price of $2.75/mcf in 2021 and $2.45/mcf thereafter;

--Pro forma production of about 370 mboepd (nearly 60% oil) in 2021 followed by annual low-to-mid single digit growth thereafter;

--Field-level and DC&E costs stay relatively flat through the forecast on a boe basis;

--Capex of $1.45 billion in 2021, following growth-linked spending thereafter;

--Prioritization of FCF towards gross debt reduction;

--Measured increases in shareholder returns following achievement of net debt targets.


RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

-- Continued credit conscious portfolio management initiatives that expand the company's economic drilling inventory;

-- Increased size and scale evidenced by production trending above 550 mboe/d with some combination of the following:

-- Stand-alone mid-cycle debt/EBITDA below 1.5x (FFO adjusted leverage below 1.5x) on a sustained basis;

-- Stand-alone debt/flowing barrel below $12,500/boe-$15,000/boe or debt/PD below $4.50/boe-$5.00/boe on a sustained basis.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

--Inability to execute on gross debt reduction targets.

-- Stand-alone mid-cycle debt/EBITDA above 2.5x (FFO adjusted leverage above 2.5x) on a sustained basis;

-- Stand-alone mid-cycle debt/flowing barrel above $17,500/boe or debt/PD above $5.50/boe on a sustained basis;

-- Material loss of operational momentum leading to lower than expected production volumes (250 mboe/d or lower) over a sustained period.


Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.


Liquidity and Debt Structure

Adequate Liquidity: Stand-alone cash and equivalents were approximately $61 million, excluding approximately $43 million held as Viper Energy Partners LP and Rattler Midstream LP, as of Dec. 31, 2020. Supplemental liquidity is provided by the company's unsecured $2.0 billion revolver due 2022, which was only drawn approximately $23 million as of Dec. 31, 2020. Fitch anticipates management will amend and extend its credit facility sometime in 2021. Additional potential liquidity sources include noncore E&P asset sales or other activities with Rattler and Viper affiliates.


REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations

Diamondback has an ESG Relevance Score of '4' for Group Structure as the company has a complex group structure with two separate MLP structures related to Viper Energy Partners, LP. and Rattler Midstream LP. This has a negative impact on the credit profile and is relevant to the rating in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of 3. This means ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.



QEP Resources, Inc.; Long Term Issuer Default Rating; New Rating; BBB; Rating Outlook Stable
----senior unsecured; Long Term Rating; New Rating; BBB
Diamondback Energy, Inc.; Long Term Issuer Default Rating; Affirmed; BBB; Rating Outlook Stable
----senior unsecured; Long Term Rating; Affirmed; BBB; Rating Watch Off
Diamondback O&G LLC; Long Term Issuer Default Rating; Affirmed; BBB; Rating Outlook Stable
----senior unsecured; Long Term Rating; Affirmed; BBB; Rating Watch Off
Energen Corporation; Long Term Issuer Default Rating; Affirmed; BBB; Rating Outlook Stable
----senior unsecured; Long Term Rating; Affirmed; BBB; Rating Watch Off

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Corporate Monitoring & Forecasting Model (COMFORT Model), v7.9.0 (1)

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