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May 23 (The following statement was released by the rating agency)
Fitch Ratings has revised Eurasia Drilling Company Limited's (EDC) Outlook to Positive from Stable and affirmed its Long-term foreign currency Issuer Default Ratings (IDR) at 'BB'. A full list of ratings actions is at the end of this release.
The Positive Outlook reflects our expectation that EDC will maintain solid credit metrics and should be free cash flow (FCF) positive in 2015-2017 as it approaches the end of its investment cycle in the Caspian Sea. EDC has a strong market position and will remain the largest on-shore driller in Russia in the medium term. The Positive Outlook also reflects the favourable business environment as Russian oil & gas companies continue to maintain high drilling volumes to battle natural oil flow declines.
EDC is the largest drilling company in Russia with a 29% market share in 2013 (by metres drilled, excluding offshore). Its ratings are constrained to the 'BB' category due to high customer concentration and limited geographical diversification beyond Russia. In 2013, OAO LUKOIL (BBB/Negative) accounted for around two-thirds of EDC's revenue, and EDC's diversification strategy will be challenged as OJSC OC Rosneft, EDC's second-largest customer, announced it will almost fully curtail cooperation with the company.
KEY RATING DRIVERS
The Positive Outlook reflects that completion risks have significantly reduced with commissioning of Neptune, its third jack-up rig in the Caspian Sea. We expect that the company's capital intensity will fall, leading to positive FCF in 2015-2017. EDC's credit metrics should remain solid despite lower on-shore drilling in 2014 due to the loss of Rosneft, its second-largest customer. We expect that EDC's key customers, LUKOIL and JSC Gazprom Neft (BBB/Negative), will maintain high drilling volumes to increase yield from their mature brownfields and bring greenfields on-line.
Russia's Largest Drilling Company
EDC is the largest drilling company in Russia, with a 29% market share in 2013. It operates in all Russia's key oil regions and is predominantly involved in onshore drilling, although its offshore business on the Caspian Sea shelf has expanded considerably over the past few years. EDC's operational scale remains constrained compared with that of larger, global oilfield services companies, such as Halliburton Company (A-/Stable) and Nabors Industries Inc. (Nabors, BBB/Negative).
EDC has a relatively modern fleet that at end-2013 included 255 land drilling and sidetracking rigs, 427 workover rigs, and three jack-up rigs for offshore drilling. In 2013, EDC's total drilling volumes reached 6,264 thousand metres, up 3.5% year-on-year, while horizontal meters reached 1,296 thousand metres, up 50.3% yoy.
LUKOIL Dominates, Rosneft Departs
LUKOIL, Russia's largest private oil company, remains EDC's top customer with 57% of onshore drilling volumes and 66% of revenues in 2013. We acknowledge the long-term relations between EDC and LUKOIL as mutually beneficial but view the high customer concentration as a rating constraint. EDC has been trying to diversify its customer base but this strategy has been challenged as Rosneft announced in 2014 it will develop its in-house oilfield service business and will almost fully curtail cooperation with EDC.
Rosneft accounted for nearly a quarter of EDC's land drilling volumes in 2013 and 20% of onshore revenues. Therefore, we expect that LUKOIL's share in EDC's revenues and earnings will increase in 2014 and a significant diversification of EDC's customer base is unlikely over the medium term. In our modelling we assume that EDC's drilling volumes will decline in 2014 by 10-15% yoy, although its higher-margin horizontal drilling and offshore drilling volumes should increase, supporting its operating cash flows.
Caspian Offshore Drilling On-track
EDC continues to step up its offshore operations in the Caspian Sea. At end-2013, EDC operated three jack-up rigs there, following commissioning of the Neptune rig in 2013. A fourth rig, Mercury, is currently under construction and EDC expects to commission it at end-2014. EDC has secured a strong position in the Caspian region, the importance of which for oil exploration is growing. In 2013, offshore drilling accounted for 5% and 16% of the company's revenue and net income, respectively, largely flat yoy.
Favourable Business Environment
Fitch believes that the outlook remains favourable for the industry, as Russian oil majors continue fighting production decline at Western Siberian brownfields, developing greenfields and tapping into shale oil deposits, which requires drilling more complex wells and leads to a significant increase in horizontal drilling. Based on Fitch's Brent price deck of USD96/bbl in 2014 and USD91/bbl in 2015, we forecast that Russian oil companies will keep up their upstream capex, which in 2013 reached USD8.3bn for LUKOIL (Russian capex only, up 18% yoy), and USD4.2bn for JSC Gazprom Neft (BBB/Negative, up 46% yoy), a sizable portion of which was spent on drilling.
Low Leverage to Remain
At end-2013 EDC's FFO adjusted net leverage was 0.6x, down from 0.8x at end-2012, while its FFO fixed charge cover reached nearly 15.5x, up from 10.3x. We expect EDC to maintain a conservative financial policy and forecast that in 2014-2017 FFO adjusted net leverage will not exceed 1x in 2014-2017 and FFO fixed charge cover will stay above 10x. This is partially due to the reduction in capex in 2015-2017 following the commissioning of the last jack up rig that EDC expects at end-2014.
Upgrade to 'BB+': We may consider an upgrade to 'BB+' if:
- FFO adjusted net leverage remains below 1.5x and FFO interest cover remains above 8x on a sustained basis.
- The fourth jack-up rig (Mercury) is commissioned without significant delays and budget overruns;
- Positive FCF starting from 2015.
- On-shore drilling volumes declining by not more than 15% yoy in 2014, at least +5% yoy in 2015.
Outlook Stabilisation: We may consider revising the Outlook to Stable if:
- FFO adjusted net leverage settles above 1.5x, and FFO interest cover below 8x on a sustained basis.
- On-shore drilling volumes decline by more than 15% yoy in 2014 and do not rebound in 2015.
We may consider a downgrade to 'BB-' if the company's FFO adjusted net leverage exceeds 2.5x on a sustained basis due to M&A, significantly higher dividends, weak operational performance or material cost overruns/delays in the Caspian Sea, which we now assess as unlikely.
DEBT AND LIQUIDITY
Comfortable Debt; Sufficient Liquidity
At end-2013 EDC had total balance-sheet debt of USD1.11bn. Its short-term debt of USD104m was well covered by cash and cash equivalents of USD629m. Fitch believes that EDC will be able to repay its upcoming maturities from its cash flows from operations.
Manageable FX Risks
At end-2013, 77% of EDC's borrowings were US dollar-denominated. We expect that its net US dollar-denominated operating cashflows from offshore drilling are sufficient to cover its US dollar-denominated debt servicing, including interest and principal and hence view EDC's currency mismatch risk as manageable. We view the Russian rouble depreciation in 1Q14 as neutral for EDC's credit profile, though it will have a negative impact on its absolute US dollar-denominated revenue and EBITDA figures in 2014, as the company reports in US dollars.
FULL LIST OF RATINGS
Eurasia Drilling Company Limited
Long-Term IDR: affirmed at 'BB', Outlook revised to Positive from Stable
Short-Term IDR: affirmed at 'B'
Long-Term local currency IDR: affirmed at 'BB', Outlook revised to Positive from Stable
Short-Term local currency IDR: affirmed at 'B'
National Long-Term Rating: affirmed at 'AA-(rus)', Outlook revised to Positive from Stable
OOO Burovaya Kompaniya Eurasia
Senior unsecured rating: affirmed at 'BB'
National senior unsecured rating: affirmed at 'AA-(rus)'
EDC Finance Limited
Senior unsecured rating: affirmed at 'BB'