TEXT-S&P raises Hercules Offshore rating to 'B'
Overview -- U.S. offshore drilling services provider Hercules Offshore Inc. is benefiting from improving day rates and utilization for its jack-up rigs in the U.S. Gulf of Mexico. -- We have raised the corporate credit rating on the company to 'B'. -- We have also raised the senior secured notes rating to 'BB-' and the senior unsecured notes ratings to 'B'. -- The stable outlook reflects our view that Hercules' operating performance and credit metrics will improve over the next year, while it maintains "adequate" liquidity. Rating Action As Standard & Poor's Ratings Services previously announced, on Nov. 2, 2012, we raised our corporate credit rating on Houston-based Hercules Offshore Inc. to 'B' from 'B-'. The outlook is stable. At the same time we raised the senior secured notes rating to 'BB-' from 'B+'. The recovery rating remains '1', indicating our expectation of very high recovery (90% to 100%) in the event of a payment default. We also raised the senior unsecured notes ratings to 'B' from 'B-'. The recovery rating remains '4', indicating our expectation of average (30% to 50%) recovery in the event of a payment default. Rationale The upgrade reflects the improving market conditions in the Gulf of Mexico and our expectations that Hercules' fleet will continue to benefit. As a result, financial measures should significantly improve over the next 12 months, with debt to EBITDA falling to approximately 3.2x by year-end 2013. The ratings on Hercules reflect Standard & Poor's Ratings Services' assessment of the company's "vulnerable" business risk and "aggressive" financial risk profiles. The ratings on Hercules incorporate its participation in the oil and gas industry's highly volatile and competitive shallow-water drilling and marine services segments as well as the elevated age of its jackup rig fleet. The ratings also incorporate our expectation that dayrates and utilization for the company's jack-up rigs in the U.S. Gulf of Mexico will remain strong for the next year. They also factor a small measure of geographic and product diversification (provided by its liftboat segments) and the company's "adequate" liquidity. Standard & Poor's views Hercules' business risk to be vulnerable. We consider the company's drilling and marine services businesses as volatile, reflecting its exposure to the variable levels of capital spending in the exploration and production industry--which, in turn, is largely reliant on volatile crude oil and natural gas prices. We also incorporate Hercules' good market position as the largest provider of jack-ups in the U.S. Gulf of Mexico (with 18 marketed rigs) and its significant liftboat presence there. Hercules maintains the leading market share position for liftboats in West Africa and the U.S. Gulf of Mexico. We believe liftboat operations are generally tied to more-stable production and maintenance activity, and liftboat demand can sharply increase because of hurricanes or other maritime incidents. We expect the supply and demand balance in the U.S. Gulf of Mexico to remain favorable for Hercules over the next year. Dayrates and utilization in the company's domestic and international offshore drilling segments are the primary drivers of Hercules' performance. Greater demand for jackup rigs, coupled with rig departures, have led to limited jackup rig availability. This has led to much higher leading edge dayrates and very high utilization levels. Our primary assumptions for the domestic offshore segment are that dayrates will average $80,000 in 2013 (up from $63,000 in the third quarter of 2012), while utilization will be 85% to 90% (utilization was 88% in the third quarter of 2012). The higher average dayrate results from rigs currently under contract that will recontract a higher, leading-edge dayrate. We also expect the company to reactivate 1 or 2 jackup rigs in the Gulf of Mexico over the next year, given the attractive economics afforded by the relatively high dayrates in the Gulf of Mexico. Utilization for the company's international offshore segment was 65% in the third quarter of 2012. We expect utilization to be at approximately the same percentage in 2013. Average dayrate in the third quarter of 2012 for the company's International Offshore segment was $93,000. However, we expect the average dayrate in the International Offshore segment to increase to $110,000 in 2013. The higher average dayrates in 2013 would be because of the addition of a new rig in 2013, which has a contract in place for approximately $125,000 per day with Saudi Aramco. Based on the above assumptions, Hercules should generate EBITDA of approximately $260 million in 2013. We have assumed capital spending of $120 million in 2013, which would result in positive free cash flow of $20 million and $820 million of total debt. Based on these assumptions, we expect debt leverage to significantly improve to about 3.2x and interest coverage to about 3.5x, versus recent results of 6.4x debt to EBITDA and 1.7x interest coverage as of June 30, 2012. Liquidity We view Hercules' liquidity as "adequate." As of Sept. 30, 2012, the company had $272 million of unrestricted cash. Other key factors include: -- We estimate near-term sources of liquidity will exceed uses by greater than 1.2x over the next 12 months. -- The company has an undrawn $75 million senior secured revolving credit facility, with a $25 million sublimit for the issuance of letters of credit. All borrowings under the new revolving credit facility mature on April 3, 2017. -- Hercules has a maximum secured leverage ratio covenant of 3.5x under its revolving credit facility, which we expect the company to be in compliance with. -- We estimate that capital spending for 2013 of $120 million will produce free cash flow of about $20 million. -- The company has no significant debt maturities until 2017. However, $66.3 million of convertible notes can be put to the company in June 2013. Recovery analysis Hercules' senior secured notes are rated 'BB-' (two notches higher than the corporate credit rating) The recovery rating on this debt is '1', indicating our expectation of very high recovery (90% to 100%) in the event of default. The recovery rating on the senior unsecured notes is 'B' (the same as the corporate credit rating). The recovery rating on this debt is '4', indicating our expectation of average recovery (30% to 50%) in the event of default. (For the full recovery analysis, see our recovery report on Hercules, published April 5, 2012, on RatingsDirect.) Outlook The stable outlook reflects our expectation that Hercules' credit ratios will improve over the next year while it maintains adequate liquidity. We could lower the ratings if leverage exceeds 5.0x or if liquidity falls below $50 million. We believe it would take a prolonged fall in utilization and dayrates for this to occur. We consider a positive rating action unlikely over the next 12 months, given the company's small size relative to peers and its dependence on the U.S. Gulf of Mexico for the majority of its cash flow generation. We would consider a positive rating action if the company improves its scale of operations and its market diversity, while maintaining leverage below 4.0x. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Upgraded To From Hercules Offshore Inc. Corporate Credit Rating B/Stable/-- B-/Stable/-- Senior Secured BB- B+ Recovery Rating 1 1 Senior Unsecured B B- Recovery Rating 4 4
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