TEXT-S&P summary: China Oilfield Services Ltd.
(The following statement was released by the rating agency)
Jan 11 -
Summary analysis -- China Oilfield Services Ltd. ------------------ 11-Jan-2013
CREDIT RATING: A-/Stable/-- Country: China
Credit Rating History:
Local currency Foreign currency
20-Dec-2012 A-/-- A-/--
The rating on China Oilfield Services Ltd. (COSL) reflects the company's 'bbb-' stand-alone credit profile (SACP) and our opinion that COSL is a strategically important subsidiary of China National Offshore Oil Corp. (CNOOC; AA-/Stable/--; cnAAA/--). COSL's SACP reflects our view that the company's business risk profile is "satisfactory" and its financial risk profile is "significant," as defined in our criteria.
We view COSL as a strategically important subsidiary of CNOOC Group and our ratings factor in three notches of uplift based on the following:
-- COSL operates in businesses that are closely related to the overall group strategy. The company's expansion outside of China through sister company CNOOC Ltd. (AA-/Stable/--; cnAAA/--) will not dilute COSL's strategic importance status within the group.
-- CNOOC Group is highly unlikely to reduce its majority ownership of COSL. It currently owns a 53.63% stake.
-- The group has a strong commitment to COSL. Some members of the group's senior management are on the board of directors of COSL. Some of the company's corporate functions are also integrated with the group.
-- COSL has a good operating record. Its brand is closely linked to the group's reputation and brand.
COSL's SACP reflects the company's solid operating record and dominant market position in offshore China as the primary contract driller and oilfield service provider to CNOOC. The company's strong contract backlog provides visibility over earnings and cash flow, and margin stability. Its well-spread debt maturity profile and strong liquidity position are added strengths. COSL's high geographic and customer concentration, significant capital expansion program for the next three years, and its higher leverage than the peer group average temper these strengths. The company's participation in the contract drilling and oilfield service industry is an additional risk. The industry is characterized by its highly competitive, cyclical, and capital-intensive nature.
We expect COSL to maintain its dominant market position in offshore China over the next five years despite intensifying competition. This is because the company has a long operating history in the area and has a deep knowledge of local geology and maritime conditions. COSL's sound relationship with CNOOC Ltd. solidifies this market position.
COSL's sizable contract backlog provides high visibility over its earnings and cash flow over the next two to three years. More than 94% of the company's revenues in 2012 and 75% of that in 2013 are contractual. In addition, COSL's long-term relationship with CNOOC Ltd. helps it to generate fairly stable operating margins despite high volatility in the drilling and oilfield service industry. COSL's EBITDA margin fluctuated between 43% in 2007 and 49.6% in 2010.
We believe COSL has higher geographic and customer concentration risk than its global peers. The top five customers accounted for over 81% of revenues in 2011, of which CNOOC Ltd. alone accounted for slightly more than 60%. However, we expect the risk to gradually reduce following the acquisition of Norway-based Awilco Offshore ASA (not rated) in 2008. The acquisition doubled COSL's drilling fleet and increased its presence in the international market. Overseas revenue rose materially to more than Chinese renminbi (RMB) 5.2 billion in 2011 from RMB1.6 billion in 2007, but it still accounts for only 28.1% of total revenue.
We project COSL's cash flow protection will improve in the next couple of years, given the company's high earnings visibility and expected earnings growth. COSL's financial risk profile will, however, remain significant because the company primarily used debt to fund the Awilco acquisition in 2008. COSL has reduced its leverage through earnings accretion, but the ratio of debt to EBITDA has remained at about 3.5x for the past two years and the ratio of funds from operations (FFO) to total debt is about 25%.
COSL's liquidity is "strong," as defined in our criteria. We expect the company's liquidity sources over the next 12-18 months to exceed its uses by more than 1.9x. Our liquidity assessment incorporates the following expectations and assumptions:
-- Sources of liquidity include cash of RMB6.7 billion as of Dec. 31, 2011, our projection of FFO of more than RMB7.5 billion, and available credit facilities of more than RMB2.8 billion (excluding uncommitted banking facilities from domestic commercial banks).
-- Uses of liquidity include capital spending that we project at about RMB5 billion, contractual debt maturities of RMB1.6 billion, working capital needs of RMB150 million, and dividend distribution of over RMB880 million in 2012.
-- We expect net sources to remain positive even if EBITDA declines by 30%.
COSL has solid relationships with its banks and has a good standing in the credit markets, particularly domestically.
The stable outlook on the rating reflects our expectation that COSL will moderately improve its financial performance over the next 12-18 months. This is because the company's high contract backlog provides good earnings visibility for the next couple of years. Following a US$1 billion bond issuance in September 2012, COSL's ratio of FFO to total debt is likely to have dropped to less than 25% in 2012. However, we expect the ratio to rebound to 25%-30% in 2013. The stable outlook also factors in our assessment of continued parental support from CNOOC.
We could raise the rating if COSL can improve its SACP by: (1) maintaining its strong market position in offshore China while expanding its operations overseas; and (2) reducing its leverage, such that the ratio of FFO to total debt is higher than 35% and its debt-to-EBITDA ratio is less than 2.5x.
The rating could come under pressure if COSL's appetite for investment is larger than we expected or operating conditions deteriorate materially over the next two years, such that the ratio of FFO to total debt is consistently less than 25%. We could also consider lowering the rating if parental support is less than we currently expect. This could happen if the group loses majority control of COSL's board, triggered by the reduction of its shareholding to less than 50%, or if we assess that the strategic importance of the company within the group is declining as a result of a change of strategy or faster expansion outside of China than we previously expected.
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