DBRS Limited (DBRS Morningstar) downgraded Source Energy Services Canada LP and Source Energy Services Canada Holdings Ltd.’s (together, the Co-Issuers) Issuer Rating and Senior Secured First Lien Notes (the Senior Notes) rating to CCC (low) from CCC (high). The Recovery Rating on the Senior Notes remains unchanged at RR4. DBRS Morningstar is maintaining the ratings Under Review with Negative Implications. DBRS Morningstar based its analysis on the consolidated financial statements of the ultimate holding company, Source Energy Services Limited (Source or the Company).
The rating downgrades follow a material deterioration in the Company’s operating environment as result of lower crude oil prices and expected deterioration in liquidity. Demand for crude oil has declined steeply as countries around the world have enforced lockdown measures to counter the spread of the Coronavirus Disease (COVID-19). While crude oil demand and pricing may recover as lockdown measures are relaxed, the timing and extent of the recovery is uncertain. Despite production cuts by OPEC+ and market-driven production shut-ins, the buildup in inventory through the lockdown is likely to keep crude oil prices well below pre-coronavirus levels in 2020 and 2021. Consequently, DBRS Morningstar expects drilling and completion activity levels, and in turn demand for frac sand, in Western Canada in 2020 to be materially lower than 2019.
DBRS Morningstar noted in its January 16, 2020, rating downgrade press release that Source has minimum flexibility to withstand a further reduction in activity levels and that there is a high degree of uncertainty associated with refinancing the Senior Notes that mature in December 2021. At the time, DBRS Morningstar expected the Company to meet its obligations in 2020 from operating cash flow and available liquidity ($18.4 million at December 31, 2019) under the asset-backed credit facility (Credit Facility) maturing in December 2021. While sales volumes and profitability in Q1 2020 was not affected materially, given the revised outlook for activity levels, operating cash flow for the remainder of 2020 is likely to be significantly lower. Source has announced some cost-reduction measures; however, they are unlikely to offset the impact of lower activity. DBRS Morningstar also expects the Company’s liquidity profile to worsen as weaker earnings put the Company at risk of breaching the minimum fixed-charge coverage ratio covenant applicable on the Credit Facility (measured monthly). While the Company was in compliance with the covenant at March 31, 2020, expected weakness in earnings from Q2 2020 onward could lead to a covenant default. DBRS Morningstar anticipates the borrowing base to trend lower as it is determined monthly based on accounts receivable and inventories. As a result, there is increased risk that, in the absence of support from its lenders, the Company could default on its interest payment on the Senior Notes due in June 2020. Consequently, DBRS Morningstar is maintaining the ratings Under Review with Negative Implications.
DBRS Morningstar may further downgrade the ratings if the Company defaults on its upcoming interest payment on the Senior Notes or if the lenders invoke a default under the Credit Facility agreement. A positive rating action would require a material improvement in the Company’s liquidity position and a successful refinancing of the Senior Notes. DBRS Morningstar will review further information as it becomes available to resolve the Under Review status within the next three months.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Rating Companies in the Oil and Gas and Oilfield Services Industries (August 23, 2019), DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 22, 2020), DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers (August 22, 2019), and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019), which can be found on dbrsmorningstar.com under Methodologies & Criteria.
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at email@example.com.
The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
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