DBRS Limited (DBRS Morningstar) confirmed CES Energy Solutions Corp.’s (CES or the Company) Issuer Rating and Senior Unsecured Notes (the Senior Notes) rating at B (high). The Recovery Rating of the Senior Notes remains unchanged at RR4. All trends are Negative. DBRS Morningstar also removed the ratings from Under Review with Negative Implications, where they were placed on March 26, 2020.
DBRS Morningstar placed the ratings Under Review with Negative Implications in response to the extreme price declines and heightened volatility in crude oil markets largely caused by the rapid spread of the Coronavirus Disease (COVID-19) and the concurrent crude oil-price war between OPEC (led by Saudi Arabia) and Russia. Subsequently, DBRS Morningstar revised its commodity price assumptions to factor in (1) the impact of the coronavirus pandemic on crude oil demand as lockdowns ease, (2) the significant buildup in global oil inventories, and (3) the impact of production cuts recently implemented by OPEC+. DBRS Morningstar also considered CES’ measures to adjust to the weaker pricing environment. The rating confirmation reflects DBRS Morningstar’s expectation that, despite the projected weakness in 2020 under the revised assumptions, the Company’s key credit metrics will improve in 2021 and 2022 and remain supportive of the current ratings. DBRS Morningstar’s approach is to rate through the cycle and give due weight to projected credit metrics when it anticipates a return to more normalized market conditions.
DBRS Morningstar believes that CES is in a better position to withstand the current downturn than the previous 2016 downturn because the Company (1) improved its market position materially since the last downturn, especially in the U.S. Permian basin; (2) increased revenue contribution from the production and specialty chemical segment where demand is driven by existing production and is typically more stable and recurring than demand in the drilling fluid segment; and (3) rationalized its cost structure and has low maintenance capital expenditures (capex). These measures have allowed CES to generate a free cash flow (FCF; cash flow after capex and dividends) surplus over the last three years, despite service pricing remaining relatively flat since the last downturn. CES has also benefitted from the growth of horizontal drilling in North America, which has increased the intensity of chemical usage. Between 2014 and 2019, North American oil and natural gas production has increased by approximately 32% while the average land rig count has reduced by 53% over the same period.
CES reduced its budgeted capex in 2020 to $30.0 million from $50.0 million; suspended common dividend payments; applied for the Canadian government’s Canada Emergency Wage Subsidy program; and initiated cost-reduction measures that should provide additional cash savings. DBRS Morningstar expects these measures, along with solid results in Q1 2020, to allow the Company to remain FCF neutral in 2020. In addition, similar to the last downturn, DBRS Morningstar expects overall debt levels to decline as the Company monetizes working capital and materially reduces the draws on its credit facilities ($93.5 million in Q1-2020). Nevertheless, DBRS Morningstar expects key credit metrics to deteriorate in 2020 as reduced drilling activity, production shut-ins, and negative pricing pressure will likely result in significantly lower earnings and operating cash flow (OCF). DBRS Morningstar expects earnings, OCF, and FCF surplus to improve in 2021 and 2022 as drilling activity improves and production shut-ins reverse on the assumption of stronger commodity prices. While earnings and OCF are unlikely to reach 2019 levels, DBRS Morningstar expects overall debt levels to be materially lower because of minimal draws under the $170.0 million and USD 50.0 million revolving credit facilities (the Credit Facility). Consequently, DBRS Morningstar expects CES’ key credit metrics to improve in 2021 and 2022 and its overall financial risk profile to remain supportive of the current rating.
DBRS Morningstar notes the outlook for crude oil demand and pricing remains fluid. While demand for drilling and completion services should increase as commodity prices increase, the magnitude of improvement is uncertain. If the recovery in commodity prices and, consequently, activity levels fall short of DBRS Morningstar’s base-case assumptions, the Company’s overall financial risk profile may not support the current ratings. The Negative trends reflect this risk, which DBRS Morningstar considers to be elevated.
DBRS Morningstar believes that the Company has sufficient liquidity to navigate the current downturn. The Senior Notes are also not repayable until October 2024. CES had drawn $93.5 million at the end of Q1 2020 under its Credit Facility maturing in September 2022. DBRS Morningstar expects the Credit Facility to remain largely unutilized over the next three years as the Company uses proceeds of an expected working capital release (due to expected lower activity levels) to pay down existing balances. Since senior debt for covenant calculations excludes the Senior Notes, CES has adequate headroom under the covenant senior debt-to-EBITDA not to exceed 2.50 times (x). The headroom under the covenant EBITDA-to-interest expense greater than 2.50x is relatively lower; however, at its option, CES can step down its minimum covenant threshold to 1.50x for three consecutive quarters. The Company can exercise its stepdown once prior to the Credit Facility’s maturity date. DBRS Morningstar expects CES to remain in compliance with the applicable covenants on the Credit Facility under its base-case assumptions.
DBRS Morningstar may change the trend to Stable if the demand/supply dynamics in the crude oil markets continue to improve, leading to greater confidence that activity levels and, consequently, the Company’s key credit metrics improve in line with DBRS Morningstar’s base-case assumptions. Conversely, DBRS Morningstar may take a negative rating action if activity levels and key credit metrics fall below DBRS Morningstar’s expectations.
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: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019); DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 22, 2020); and DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers (August 22, 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 firstname.lastname@example.org.
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.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.
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