TEXT-S&P revises Key Energy Services outlook to positive

Fri Sep 28, 2012 5:10pm EDT

Overview
     -- U.S. oilfield services company Key Energy should continue to benefit 
from strong levels of oil-directed drilling. We expect Key's financial 
performance to remain strong for the rating.
     -- We are revising the outlook to positive from stable and affirmed the 
'BB-' corporate credit rating.
     -- The positive outlook reflects the potential for an upgrade in 2013 if 
market conditions do not substantially decline from current levels.

Rating Action
On Sept. 28, 2012, Standard & Poor's Ratings Services revised its outlook on 
Houston-based Key Energy Services Inc. to positive from stable and affirmed 
its 'BB-' corporate credit rating on the company.

Rationale
The positive outlook reflects Key's improved financial and operating 
performance since 2008's industry-wide downturn. We expect near-term financial 
measures to remain strong for the rating in 2012 and 2013, with debt leverage 
of about 2.5x and funds from operations (FFO) to debt of about 30%. Although 
market conditions in the oilfield services industry have weakened in 2012 we 
believe industry conditions will remain supportive well through 2013, and will 
result in good credit metrics for the company. We forecast that it would take 
a greater than 45% fall from current EBITDA to approach our downgrade trigger 
of 3.75x debt leverage. Based on our current crude oil price assumptions of 
$80/bbl in 2013 and $75/bbl thereafter, we expect demand for oilfield services 
should remain adequate for the sector. It would likely take a precipitous 
downturn in crude prices, such as what occurred in 2008, when West Texas 
Intermediate (WTI) briefly fell to about $34/bbl, resulting in curtailment in 
capital spending by the exploration and production industry.

Finally, we expect the rapid growth in shale-oil wells to benefit Key's core 
workover rig division, used primarily to recondition and/or recomplete wells, 
supporting longer-term operational and financial performance. Eventual natural 
reserve production declines will increase demand for Key's services to arrest 
those declines and maintain production levels and well profitability. 

The rating on Key Energy Services Inc. reflects our view of the company's 
"weak" business risk and "aggressive" financial risk profiles, as well as its 
"adequate" liquidity assessment. The company benefits from its diversification 
across the major U.S. oil and gas plays. This limits the negative effects to 
operational performance from a downturn in a specific basin or play, such as 
occurred in the Haynesville Shale. Key should also benefit from its growing 
international operations, which will add market diversity and buffer the more 
volatile North American market. Nevertheless, the well services industry 
remains volatile and exposed to the spending levels of the exploration and 
production industry. Repeated downward earnings guidance throughout the 
industry in 2012 points to this; however, we currently do not expect a 
significant decrease in demand for well services.

Key's financial results should remain solid. Based on our assumptions of 
revenue growth of 20% and gross margins of 31% in 2012, EBITDA should be about 
$390 million, total debt should be about $935 million, and FFO should be about 
$334 million. As a result, financial performance for 2012 should remain solid, 
with leverage of about 2.5x, FFO to debt of about 35%, and interest coverage 
of about 8x. 2013's estimated results reflect the weakening in market 
conditions during 2012. As a result, we have assumed no revenue growth and 
gross margins of 30%. These assumptions would yield EBITDA of about $370 
million, FFO of about $310 million, and total debt of $1 billion. Financial 
measures remain adequate for ratings with debt leverage of between 2.5x to 
3.0x, FFO to debt of about 30% and interest coverage of 6.5x. 

We view Key's business risk profile as weak. Key is one of the largest and 
geographically diverse companies in the U.S. onshore well-services industry, 
with Nabors Industries Inc. and Basic Energy Services Inc. as its closest 
competitors. As a result, Key has been able to buffer the fall in natural gas 
drilling, particularly in the Haynesville Shale, by its positions in oilier 
markets such as California, Permian Basin and the Bakken and Eagle Ford 
Shales. About 80% of Key's revenues are tied to crude oil or NGLs. 
Nevertheless, despite continued demand for its service offerings, Key faces a 
very challenging and competitive market. 

In addition to its exposure to unpredictable exploration and 
production-company spending, Key faces competition from smaller regional 
companies, particularly in pricing at times of low utilization. Nevertheless, 
thanks to its strong market position geographic diversity, including about 15% 
of revenues outside North America, we expect Key to maintain adequate 
operating performance to support expected financial measures. 

In 2012, the U.S. oilfield services industry faced difficult circumstances, 
and we expect it to face further headwinds in the remainder of 2012 and into 
2013. The rapid increase in both natural gas and oil drilling through 2011 led 
to high equipment orders throughout the oilfield services industry as 
operators tried to take advantage of very strong demand from E&P operators for 
completion and other services equipment. However, with the drop in natural gas 
drilling that began in 2011, there has been an oversupply of equipment in most 
markets compounded by a very competitive labor market. 

As a result, Key's coiled tubing segment has underperformed expectations due 
both to delays in 2011 equipment deliveries and a shortage of labor in Key's 
markets at a time of softening margins. Likewise, market conditions have 
softened in Key's other segments, reflected in the recent announcement that 
revenues would decline 4% to 5% and operating margins 250 basis points to 350 
basis points in the third quarter. Nevertheless, we currently expect that 
strong oil-directed drilling activity will act as a buffer to help support 
Key's operations. We expect that as many of the shale-based oil wells drilled 
over the past two years begin to see production declines, Key's core well 
servicing business, about 40% revenues, should benefit as companies 
recondition and/or recomplete wells to support production levels. As a result, 
we expect Key's operational and financial performance to remain adequate for 
the ratings, despite the near-term difficulties. 

Liquidity 
We assess Key's sources of liquidity as "adequate." Key factors include:
     -- $650 million secured credit facility due March 2016 with $550 million 
commitments. 
     -- Estimated availability on the credit facility of about $250 million to 
$260 million pro forma for its maximum debt to capital covenant of 45%.
     -- Sources of liquidity should exceed uses by 1.2x or greater.
     -- Based on our assumed capital spending of $375 million in 2012 and 
2013, Key would outspend operating cash flows by about $160 million through 
2013.
     -- Expectation that Key will remain in compliance with financial 
covenants.

Covenants include:
     -- Maximum debt leverage of 47.5% in Sept. 30, 2012, and 45% thereafter.
     -- Maximum secured debt leverage of 2.0x.
     -- Minimum interest coverage of 3x.

Finally, if market conditions were to substantially weaken from current 
levels, something we do not currently expect, we believe Key would reduce 
capital spending to preserve liquidity.

Recovery analysis
For the complete recovery analysis, see Standard & Poor's recovery report on 
Key Energy Services, published on RatingsDirect on April 25, 2012.

Outlook
The positive outlook reflects the potential for an upgrade in 2013 if market 
conditions do not substantially decline from current levels, and we maintain 
our stable outlook on the industry. For an upgrade we expect Key to maintain 
debt leverage under 3.75x through most points in the industry cycle. However, 
much of the exploration and production industry, Key's customer base, remains 
cautious about 2013 capital spending levels because of uncertainty over the 
U.S. political and regulatory environment following the November elections and 
the impact to oil prices from the struggling European and weakened Asian 
economies. We expect to review Key in the first half of 2013.

We could stabilize ratings if market conditions significantly decline such 
that Key's ability to maintain its above-average financial measures is tested 
by either market conditions or financial policy. One challenge might be 
aggressive capital spending if market softening persists, such as that debt 
leverage would exceed 4x.

Related Criteria And Research
     -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 
2012
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
     -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
     -- Corporate Ratings Criteria 2008, published April 15, 2008
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List
Ratings Affirmed; Outlook Revised To Positive
                                        To                 From
Key Energy Services Inc.
 Corporate Credit Rating                BB-/Positive/--    BB-/Stable/--
 Senior Unsecured                       BB-                
   Recovery Rating                      4
FILED UNDER:
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