TEXT-S&P rates Russia's Eurasia Drilling 'BB/B'
Overview -- Russia-based Eurasia Drilling Co. (EDC) is a leading player in Russia's oilfield services market, with an increasingly diverse mix of services and an expanding customer base beyond its main customer OAO LUKoil. -- It is nevertheless exposed to Russian country risk and the cyclical and competitive oil field services industry. -- We are assigning our 'BB' long-term, 'B' short-term, and 'ruAA' Russia national scale ratings to EDC. -- The positive outlook reflects the possibility that we could raise the rating in the next 12 months if EDC can continue to increase its EBITDA, sustain healthy margins, and maintain a moderate financial policy. Rating Action On June 21, 2012, Standard & Poor's Ratings Services assigned its 'BB' long-term and 'B' short-term corporate credit ratings to Eurasia Drilling Co. (EDC), a Russia-based oilfield services company. The outlook is positive. We also assigned an 'ruAA' Russia national scale rating. Rationale The ratings on EDC are constrained by the cyclicality and competitiveness of the oilfield services industry and its dependence on the capital spending levels of oil and gas companies. Furthermore, EDC has a relatively aged asset base, leading to substantial investment needs, and faces country risks from operating in Russia. The ratings are supported, however, by EDC's longstanding relationship with its main customer LUKoil OAO (BBB-/Positive/--), which is responsible for 61% of revenues. This provides important barriers to entry, although it also implies a degree of customer concentration. Other supportive rating factors include the currently favorable market conditions, and lower volatility in the oilfield services industry in Russia than in the global market as a whole. Furthermore, EDC is improving the age structure of its fleet rigs, increasing its client base and mix of services, and it demonstrates healthy credit metrics. EDC reported $593 million of adjusted EBITDA on revenues of $2,752 million in 2011. Its net adjusted debt stood at $268 million as of Dec. 31, 2011, which translates into a Standard & Poor's-adjusted debt-to-EBITDA ratio of about 0.5x. We assess EDC's business risk profile as "fair" under our criteria. Although the oil field services industry as a whole is cyclical, we view Russian market conditions as relatively favorable, thanks to supportive oil prices, a rising share of hard-to-recover reserves, and a further ramp-up in capital expenditures by oil and gas producers. We also consider Russian oil and gas companies less sensitive to commodity price volatility than their international peers, owing to the natural hedge created by the Russian oil tax system. EDC holds a leading position in Russia's drilling market, with a market share of 25% in 2011. The company improved its market position and diversified its service mix after acquiring the sidetracking and workover assets of Schlumberger Ltd. and the offshore jack-up rig Saturn (formerly Trident XX) from Transocean in 2011. This, together with an increase in its provision of horizontal drilling services, is helping EDC shift from conventional drilling toward more complex and high-value-added services. Following EDC's acquisition of Schlumberger assets, it also decreased the portion of rigs older than 15 years from 65% in 2010 to 58% in 2011, although rig fleet remains rather aged. EDC's historical concentration on a single customer, LUKoil, somewhat limits its ability to adjust prices related to onshore drilling services. However, its long-term relations and interdependence with LUKoil also provide revenue visibility and a significant barrier to entry, as EDC carries out approximately 95% of LUKoil's drilling. This makes the company difficult to replace, as no other drilling company in Russia has a comparable scale of operations and asset base. Moreover, EDC's drilling volumes could be boosted by LUKoil's expansion in the Caspian Sea and Iraq. We view EDC's financial risk profile as "significant" under our criteria, constrained by its sizable investment program to expand both its offshore and onshore drilling and modernize its existing fleet. In our base-case scenario, we estimate EDC's capital expenditures will be about $500 million per year within the next few years. EDC's gross adjusted debt is high at $762 million, although we consider most of its reported cash of $494 million as surplus cash and currently net it from debt. We believe that EDC's financial metrics will stay strong, bolstered by further steady EBITDA growth to $700 million-$800 million over 2012-2013 and supported by prudent corporate governance and financial policies. We project that EDC will generate considerably positive free operating cash flow of $60 million in 2012-2013, after $8 million in 2011, despite its sizable investment program. Liquidity EDC's liquidity is "adequate" as defined by our criteria. We consider the company's risk management to be generally prudent and its relations with Russian banks as sound. We estimate EDC's ratio of potential sources to potential uses of liquidity at about 1.4x for the 12 months starting April 1, 2012, and at 1.5x for the following 12 months. As of April 1, 2012, we estimate EDC's liquidity needs over the 12 months to be about $730 million, comprising: -- Debt maturities of about $190 million in the 12 months to March 31, 2013, and $195 million in the following 12 months; -- Capital expenditures of about $480 million-$500 million; -- Working capital outflows of about $20 million; and -- A small acquisition of about $20 million. We estimate EDC's liquidity sources to be about $1,030 million. These include: -- Surplus cash of about $432 million, excluding $50 million of cash that we consider to be tied to operations; and -- Funds from operations, which we estimate in our base-case credit scenario at about $600 million, factoring in steady EBITDA growth. EDC is subject to maintenance covenants under several of its bank loan agreements. The strictest of them limit the net debt-to-EBITDA ratio to 2.0x and the interest coverage ratio to not less than 3.0x. We consider that the headroom for the April 1, 2012, test is robust and will remain so in the future, with net debt to EBITDA closer to 0.5x under our base-case scenario. Outlook The positive outlook reflects the possibility that we could raise the rating on EDC by one notch in the next 12 months if the company successfully progresses with its expansion plans, resulting in a gradual increase of EBITDA from $600 million in 2011 to $700 million-$800 million in 2012-2013. This also assumes that market conditions in oil field services in Russia stay positive over the medium term, supported by continued high oil prices, despite increased global macroeconomic uncertainties. Any upgrade will also be subject to EDC's ability to maintain satisfactory profitability, with an EBITDA margin in the 20%-25% range. It would also depend on EDC further adhering to a prudent financial policy, with adjusted net debt to EBITDA of less than 1.0x under normal conditions, rising temporarily to 1.5x in a downturn. We could potentially revise the outlook to stable or see rating pressure in general if EDC's liquidity weakened, if it faced a severe cyclical downturn, or undertook an unexpectedly sizable debt-financed acquisition, leading to adjusted net debt to EBITDA deteriorating to 2x or more, without near-term prospects of recovery. Related Criteria And Research All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated. -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 -- Principles Of Credit Ratings, Feb. 16, 2011 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 Ratings List New Rating Eurasia Drilling Co. Corporate Credit Rating BB/Positive/B Russian national scale ruAA/--/-- Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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