DBRS Confirms Penn Virginia Resource Partners at BBB (low)

Dominion Bond Rating Service (“DBRS”) has today confirmed the rating of Penn Virginia Resource Partners, L.P. (“PVR” or the “Company”) at BBB (low). The trend is Stable.

The rating for PVR remains on track. With the 2005 acquisition of the majority of the assets of Cantera Natural Gas LLC (“Cantera”), the Company has diversified into the mid-stream oil and gas business. The US$191 million Cantera acquisition was initially debt-funded, but an equity offering decreased the Company’s gross leverage into the 45% range. This level is expected to decrease over time as the Company continues to make acquisitions and rebalance its capital structure. The Company’s financial profile remains in line with its BBB (low) rating following the Cantera transaction.

DBRS notes that the rating is underpinned by PVR’s coal business (e.g. leasing coal properties), which provides a steady royalty revenue stream and favourable cash flow generating fundamentals. The lessees are responsible for all the operating, transportation, capex, and personnel costs (including posting environmental bonds at the leased properties). The business risk retained by the Company comprises matching operators to its properties to maximize production and hence, royalty revenue. This is critical as the need to switch lessees is disruptive to the royalty stream. Cash flow generation has been growing (in line with coal royalty tonnage growth) and has resulted in strong cash flow coverage ratios (year-end 2005 cash flow-to-debt was 0.39 times; a five-year average of 0.42 times). This has been the key to supporting higher debt levels.

With the Cantera acquisition, the Company also adds gas diversification to its earnings base. The Cantera assets generate revenue from gas gathering and processing systems in Texas and Oklahoma. Operational risk associated with any single producer is small, as the Company has contracts with hundreds of gas producers. Furthermore, a variety of contracts and an active hedging program reduces the commodity risk associated with this type of business. PVR is targeting to hedge about 75% of the anticipated natural gas liquids (NGL) exposure to its percentage of proceeds (POP) and keep-whole contracts (representing 30% and 45%, respectively, of the total contract mix), while hedging a similar amount of its gas exposure.

DBRS notes that the mid-stream natural gas and processing business has much lower gross margins (in the range of 10%-15%) than PVR’s coal business. For example, gross margins fell to 31.9% in 2005 from 98.5% in 2004 due to the Cantera acquisition. It should be noted that these are typical margins in the mid-stream gas business.

Going forward, PVR is likely to use debt to partially fund acquisitions in the future. Along this acquisitive path, which is expected to include both coal and mid-stream assets, PVR’s intention is to maintain a moderate financial profile. Management has targeted a debt-to-total capital ratio of 40% to 45%, a reasonable level for the rating. Sustaining capex will remain quite low, while scheduled debt amortization should be easily covered with free cash flow generation over the mid term.