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 and the Stable trends are underpinned by CES’ leading market position in Canada, its growing market position in the U.S., and DBRS Morningstar's expectation that the key credit metrics will remain supportive of the rating.
CES' earnings and operating cash flow (OCF) in 2022 were materially higher, driven by an increase in industry activity levels and market share gained since the downturn in 2020. While the Company was able to realize product price increases, profit margins in 2022 were relatively flat because of inflationary pressure on product and labour costs. The Company generated a material free cash flow (FCF; OCF after capital expenditures and dividends) surplus in 2022. However, higher activity levels 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 YE2022 compared with YE2021. Nevertheless, higher earnings and cash flow offset the impact of higher debt, and the Company's key credit metrics improved in 2022. 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.
DBRS Morningstar's crude oil and natural gas price assumptions for 2023 are conservative. Consequently, DBRS Morningstar expects industry activity levels to moderate in 2023. Inflationary pressure on costs is expected to continue to persist in parts of the business; however, the impact should be less pronounced than the last two years. While earnings and OCF are expected to decline modestly, DBRS Morningstar expects the Company to generate a meaningful FCF surplus in 2023. DBRS Morningstar expects the Company to direct the FCF surplus along with an expected working capital inflow primarily toward reducing debt. DBRS Morningstar expects the Company to maintain its lease-adjusted debt-to-cash flow ratio at or around 3.0 times (x) to 3.5x. CES has increased the size and extended the maturity date of its credit facilities, which should provide CES with adequate liquidity to meet higher demand if commodity prices stay elevated for longer and repay the Senior Notes if required. DBRS Morningstar expects the Company to comply with applicable financial covenants.
DBRS Morningstar may consider a positive rating action if CES maintains its market position and reduces debt meaningfully, bolstering DBRS Morningstar's confidence that the Company will maintain its lease-adjusted debt-to-cash flow ratio at or around 2.5x through commodity price cycles. 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.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.
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 (May 17, 2022) https://www.dbrsmorningstar.com/research/396929.
All figures are in Canadian dollars unless otherwise noted.
DBRS Morningstar applied the following principal methodologies:
-- Global Methodology for Rating Companies in the Oil and Gas and Oilfield Services Industries (August 31, 2022) https://www.dbrsmorningstar.com/research/402196
-- DBRS Morningstar Global Criteria: Guarantees and Other Forms of Support (March 28, 2023) https://www.dbrsmorningstar.com/research/411694
-- DBRS Morningstar Global Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (September 1, 2022) https://www.dbrsmorningstar.com/research/402218
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.
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