Fitch Ratings has placed the Long-Term Issuer Default Rating (IDR) of
Fitch has also placed the first-lien revolver and the senior second-lien notes on Rating Watch Positive. The rating action follows Talos' announcement that it is acquiring
Talos' ratings reflect its higher margin, liquids-focused asset profile with current production in the low- to mid-60 thousand barrels of oil equivalent per day (mboepd). The ratings also consider a positive FCF profile over the forecasted period; conservative balance sheet; attractive exploitation and exploration inventory, and adequate liquidity. This is offset by potentially significant environmental remediation costs and relatively higher operating costs.
The Rating Watch Positive reflects the credit accretive nature of the acquisition and increased production scale.
Key Rating Drivers
Credit-Friendly Acquisition: Talos recently announced that it has entered into an agreement to acquire EnVen for
Enhanced Gulf of Mexico Position: Pro forma, Talos will materially expand the combined company's size and scale in the
Improving Liquidity Situation: Talos has taken actions to improve its liquidity position, including the note refinancing in late-2020 and the note add-on stock offering in early-2021. The company has reduced borrowings under the credit facility by
Capex Supports FCF Generation: Talos is expected to generate positive FCF based on Fitch's price deck (
Substantial Decommissioning Costs: Due to the company's focus on mature offshore assets and an active M&A strategy, Talos' environmental remediation costs for P&A are elevated compared with onshore peers. Asset retirement obligations (AROs) as of
Carbon Capture and Storage: Talos is creating a subsidiary to explore opportunities in Carbon Capture and Storage (CC&S) and use its expertise in conventional oil and gas geology, engineering and project delivery. The company has announced a letter of intent to develop a CC&S project with
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer
WTI oil prices of
Premium differentials of
Production slightly lower in 2022 due to drydocking and mid, single-digit increases thereafter;
Capex including P&A of
FCF allocated toward paydown of revolver.
KEY RECOVERY RATING ASSUMPTIONS
The recovery analysis assumes that
Going-Concern (GC) Approach
Fitch assumed a bankruptcy scenario exit EBITDA of
An EV multiple of 3.75x is applied to the GC EBITDA to calculate a post-reorganization enterprise value versus the historical energy upstream sub-sector multiple of 2.8x-5.6x for recent E&P bankruptcies, and median EV/EBITDA multiples in observed offshore transactions in the 2.0x-4.0x range. The lower multiple also reflects the impact of Asset Retirement Obligations and Surety bonds.
These assumptions lead to an EV of
Liquidation Approach
The liquidation estimate reflects Fitch's view of the value of the company's E&P assets that can be realized in sale or liquidation processes conducted during a bankruptcy or insolvency proceeding and distributed to creditors. Fitch used historical transaction data for the GoM blocks on a $/bbl, $/1P, $/2P, $/acre and PDP PV-10 basis to attempt to determine a reasonable sale, based on Talos' recent M&A transactions, other recent offshore M&A transactions, and valuations from emerging, offshore bankruptcies of
Fitch assumed a 25% advance rate on A/R given that in a pro-longed downturn, A/R would likely decrease. Fitch valued the oil & natural gas assets at
Waterfall Analysis
Fitch assumed the
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Upon completion of the EnVen acquisition, Talos' rating will likely be upgraded;
Material reduction of the revolving credit facility through proceeds from FCF generation;
Increased size and scale evidenced by production trending above 75mboepd-100mboepd;
Demonstrated ability to manage P&A obligations and reduced AROs per flowing barrel or proved reserves;
Midcycle debt/EBITDA sustained below 2.5x and FFO leverage below 3.0x.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Loss of operational momentum, evidenced by production trending below 45mboepd;
Reduction in liquidity due to lower bank commitments or increased revolver borrowings;
Midcycle debt/EBITDA above 3.5x on a sustained basis and FFO leverage above 4.0x;
Unfavorable regulatory changes, such as increased bonding requirements, or accelerated P&A spending;
Implementation of a more aggressive growth strategy operating outside FCF;
Inability to manage P&A obligations.
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 '
Liquidity and Debt Structure
Adequate Liquidity, Clear Maturities: The second-lien notes issuance in late 2020 and early 2021 extends the next bond maturity to 2026, while reducing borrowings under the credit facility. The reserve-based loan (RBL) matures in
Fitch expects Talos will generate positive FCF over the forecasted horizon and use proceeds to further reduce the outstanding amounts on the revolver. Management stated that capital budgets would be determined on the ability to generate FCF even in commodity price declines. The company's hedging program provides some protection, but an enhanced program would provide more comfort.
Issuer Profile
Talos is a publicly traded, technically driven independent exploration and production company with operations in the
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
These factors have a negative impact on the credit profile, and is relevant to the ratings 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
RATING ACTIONS
Entity / Debt
Rating
Recovery
Prior
LT IDR
B-
Rating Watch On
B-
senior secured
LT
BB-
Rating Watch On
RR1
BB-
Senior Secured 2nd Lien
LT
B
Rating Watch On
RR3
B
LT IDR
B-
Rating Watch On
B-
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Additional information is available on www.fitchratings.com
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