Frontera Energy’s Cost Cutting Is a Positive Development, Says Fitch

Fitch Ratings believes Frontera Energy’s (TSX: FEC) cost cutting initiative and reduction in production volumes are positive developments to preserve the company’s strong liquidity position. Overall profitability is expected to decrease in 2020 as a result of lower crude prices. Fitch estimates pro forma 2020 EBITDA to be $145 million USD, a 73% decrease from 2019. The 2020 EBITDA figure assumes an average realized price for Brent of $30bbl USD, applying Fitch’s $35bbl USD price assumption for 2020 and a $5bbl USD Vasconia discount, total annual average production of 48,000boed in 2020 and adding back reported impairment cost of $150 million USD in 1Q2020.

Gross Leverage, defined as total debt to EBITDA, is expected to be 2.3x in 2020, with a single $331 million debt maturity due in 2023. Total debt to 1P is expected to remain less than $3.00 per 1P of reserves, and the 32% drop in production will result in an increase in 1P reserve life to 6.5 years, assuming the same level of 1P reserves reported in 2019 of 115 million barrels of equivalent, up from 4.4 years in 2019, should reserves not be revised downwards as a result of the lower price environment.

Debt service coverage, FFO to interest expense, is projected to be 5.1x in 2020. On May 7, 2020, the company announced cost cutting initiatives aimed to maintain profitability while weathering the volatile pricing environment. The announced reduction of $30 million-$35 million from SG&A, $100 million in operating costs, $30 million in transportation and adjusted down capex to $80 million-90 million, from its original guidance of $325 million-375 million. Collectively these measures along with having 21,000bbls of its production hedged through 3Q20 can stabilize cash flow and preserve its liquidity profile, as Brent’s price recover.

Frontera Energy is rated ‘B-‘ on Rating Watch Negative. The rating reflects the company’s rigid cost structure associated with fixed transportation costs. These costs limit its flexibility when coping with the low oil price environment, given its full-cycle costs and relatively short reserve life. Fitch estimates Frontera’s half-cycle cost of $26.9bbl and full-cycle cost averages $40.4bbl. EBITDA margins are expected to decrease to 27% in 2020 from 35% in 2019. The lower EBITDA margin, compared to peers, is explained by the company’s fixed transportation cost, which averages $11.5-12.50 per barrel, representing roughly 25%-30% of revenues historically.

Photo courtesy Frontera Energy