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S&P lwrs Milagro Oil & Gas Rtg To 'ccc+'; outlook negative
March 20, 2012 / 9:38 PM / 5 years ago

S&P lwrs Milagro Oil & Gas Rtg To 'ccc+'; outlook negative

March 20 (Reuters) - User	
Overview	
     -- We believe U.S. oil and natural gas exploration and production (E&P) 	
company Milagro Oil & Gas Inc.'s liquidity will deteriorate in 2012. 	
     -- We are lowering our corporate credit rating to CCC+. 	
     -- The outlook is negative and reflects the company's tightening 	
liquidity position and highly leveraged balance sheet. 	
	
Rating Action	
On March 20, 2012, Standard & Poor's Ratings Services lowered its corporate 	
credit rating on Houston-based Milagro Oil & Gas Inc. (Milagro) to 'CCC+' from 	
'B-'. The outlook is negative.	
	
We lowered the issue-level rating on Milagro's second-lien secured notes to 	
'CCC+' (same as the corporate credit rating) from 'B-'. The recovery rating 	
remains '4', indicating our expectation of average (30% to 50%) recovery in 	
the event of a payment default. 	
	
Rationale	
The rating action reflects Milagro's increasingly tight liquidity. Milagro had 	
$5.6 million of cash and $127.5 million drawn on its revolver as of Sept. 30, 	
2011. We believe that Milagro currently has very minimal cash balances and has 	
drawn further under its revolving credit facility. We also expect the 	
company's $180 million borrowing base to decline by 15% to 20% due to lower 	
natural gas prices and for Milagro to use its funds from operations and 	
revolver availability in the remainder of 2012 to fund capital spending. As a 	
result, we estimate that the company will have less than $25 million of 	
liquidity (combination of cash and revolving credit facility availability) at 	
some point this year. In addition, we believe that the company has very little 	
cushion relative to anticipated performance levels on the maximum leverage 	
ratio covenant contained in the credit facility. 	
	
The rating on Houston-based Milagro Oil & Gas Inc. reflects the company's 	
relatively small asset base and production levels, significant exposure to 	
natural gas prices, historically weak reserve replacement metrics, and high 	
leverage. The ratings also reflect the company's longer reserve life relative 	
to other Gulf-based E&P companies and weak liquidity position. 	
	
Standard & Poor's classifies Milagro's financial risk as "highly leveraged" 	
(as our criteria define the term). As of Sept. 30, 2011, Milagro had 	
approximately $650 million of total adjusted debt, including our analytical 	
adjustments for operating leases, accrued interest, and asset retirement 	
obligations. Total adjusted debt to EBITDAX (EBITDA plus exploration expense) 	
for the last 12 months ended Sept. 30, 2011, was a very aggressive 6.5x and 	
EBITDAX to interest coverage was 2.2x. Moreover, on a third-quarter 2011 	
annualized basis, total adjusted debt to adjusted EBITDAX was worse--at 8.3x. 	
Under Standard & Poor's hydrocarbon pricing assumptions of $3 per million Btu 	
Henry Hub natural gas and $80 per barrel of West Texas Intermediate crude oil 	
for 2012 as well as production volumes held at 2011 level, we expect that 	
year-end 2012 debt leverage will be in the very aggressive 8x to 9x range 	
(including preferred equity as debt), as the remainder of the company's 	
favorable natural gas hedges roll off. 	
	
We view Milagro's business profile as "vulnerable". The company's proved 	
reserve base totaled a relatively small 220 billion cubic feet equivalent 	
(Bcfe) as of Dec. 31, 2010, and we expect production was about 48 million 	
cubic feet equivalent per day (mmcfed) for the 12 months ended Dec. 31, 2011. 	
This positions Milagro at the low end of our market position relative to rated 	
E&P companies. Milagro's reserve base also has a significant exposure to 	
natural gas (61% of reserves as of Dec. 31, 2010).Still, reserve life was 	
approximately 11 years in 2010, but was about seven years on a proved 	
developed basis. The company has a fair amount of operating diversity with 	
operations in Texas, Louisiana, and the Gulf of Mexico. The company derives 	
approximately 96% of its production from its onshore assets. 	
	
Milagro has a relatively high cost structure, with cash costs (lease operating 	
expenses, general and administrative, and production taxes) at about $3.72 per 	
mcfe (thousand cubic feet equivalent) and unlevered costs (production costs 	
plus depreciation and amortization) at about $6.52 per mcfe for the second 	
quarter of 2011. 	
	
As is typical for Gulf Coast E&P companies, acquisitions have played a key 	
role in the company's growth strategy and reserve replacement strategy, as 	
production has far outpaced organic reserve replacement in the past several 	
years. From 2008 through 2010, extensions and discoveries replaced only 44% of 	
production. We expect that the company will continue to make periodic 	
acquisitions to grow its reserves and production levels, as evidenced by its 	
September 2011 acquisition of South Texas Assets, which added proved reserves 	
of 15.0 Bcfe and 3.0 mmcfe per day of production net to Milagro.	
	
Liquidity	
In our view, Milagro's liquidity is "weak". Milagro had $5.6 million of cash 	
and $127.5 million drawn on its revolver as of Sept. 30, 2011. We believe that 	
Milagro currently has very minimal cash balances and has drawn further under 	
its revolving credit facility. We also expect the company's $180 million 	
borrowing base to decline by 15% to 20% due to lower natural gas prices. We 	
expect Milagro to use its funds from operations and revolver availability in 	
the remainder of 2012 to fund capital spending. As a result, we estimate that 	
the company will have less than $25 million of liquidity (combination of cash 	
and revolving credit facility availability) at some point this year. In 	
addition, we believe that the company has very little cushion relative to 	
anticipated performance levels on the maximum leverage ratio covenant 	
contained in the credit facility. 	
	
Recovery analysis	
For a complete recovery analysis, please see our recovery report on Milagro 	
Oil & Gas Inc. to be published on RatingsDirect following the release of this 	
report.	
	
Outlook	
The negative outlook reflects the company's tightening liquidity position and 	
highly leveraged balance sheet. We would consider a negative rating action if 	
the company's liquidity deteriorates further. A revision of the outlook to 	
stable would require an improvement in the company's liquidity and development 	
of a more consistent track record in production and reserve growth.	
	
Related Criteria And Research	
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 	
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008	
	
Ratings List	
Downgraded	
                                        To                 From	
Milagro Oil & Gas Inc.	
 Corporate Credit Rating                CCC+/Negative/--   B-/Negative/--	
 Senior Secured                         CCC+               B-	
  Recovery Rating                       4                  4

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