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) with Stable trends. The recovery rating on the Senior Notes remains unchanged at RR4. The rating confirmations are underpinned by CES’ leading market position in Canada and its growing market position in the U.S., both of which have strengthened since the downturn in 2020. The Stable trends acknowledge the improvement in the Company's key credit metrics in 2021 and reflect DBRS Morningstar's expectation that the key credit metrics will continue to improve in 2022.
CES' earnings and operating cash flow (OCF) in 2021 were materially higher as stronger commodity prices led to a rebound in drilling and completion activity levels in North America. Although gross margins have come under pressure because of inflationary pressure on product and labour costs, the Company has been able to partially offset the impact through product price increases and a strategic buildup in inventory. Despite the reinstatement of dividends in 2021, the Company generated a material free cash flow (FCF; OCF after capital expenditures and dividends) surplus in 2021. However, materially higher activity levels and a strategic buildup in inventory led to a significant working capital surplus, which the Company funded through draws on its revolving credit facilities. As a result, the Company's overall debt levels were materially higher at YE2021 compared with YE2020. Nevertheless, higher earnings and cash flow offset the impact of higher debt, and the Company's key credit metrics improved in 2021. DBRS Morningstar notes that the Company has an established track record of monetizing its working capital during periods of lower activity levels with relatively insignificant bad debt expense.
Earnings and OCF are expected to improve in 2022 based on DBRS Morningstar's base-case crude oil and natural gas price assumptions, and activity levels. Although inflationary pressures on product and labour costs are expected to pressure margins in 2022, DBRS Morningstar expects the Company to achieve product price increases with its customers through the year albeit with some lag. DBRS Morningstar also expects the Company to generate a meaningful FCF surplus in 2022, yet overall indebtedness is expected to remain relatively flat as the FCF is primarily used to fund the working capital surplus and shareholder returns. Consequently, DBRS Morningstar expects the key credit metrics to improve modestly in 2022 with the lease-adjusted debt-to-cash flow ratio at or around 3.0 times (x) to 3.5x. DBRS Morningstar notes that the Company has increased the size and extended the maturity date of its revolving credit facilities, which should provide CES with adequate liquidity to meet higher demand if commodity prices stay elevated for longer. DBRS Morningstar also expects the Company to comply with applicable financial covenants.
DBRS Morningstar may consider a positive rating action if CES continues to improve its market position and/or increases diversification. A meaningful reduction in indebtedness, including the Senior Notes that mature in October 2024, could also trigger a positive rating action. Although unlikely, DBRS Morningstar may consider a negative rating action if activity levels and key credit metrics are materially and consistently below DBRS Morningstar’s expectations.
There were no environmental, social, or governance factors with a significant or relevant impact on the credit rating.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
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 16, 2021; https://www.dbrsmorningstar.com/research/383104), DBRS Morningstar Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (August 19, 2021; https://www.dbrsmorningstar.com/research/383238), and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (April 4, 2022; https://www.dbrsmorningstar.com/research/394683), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).
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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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