Nov 21 -
Summary analysis -- Eurasia Drilling Co. -------------------------- 21-Nov-2012
CREDIT RATING: BB/Positive/B Country: Russia
Primary SIC: Oil and gas field
Credit Rating History:
Local currency Foreign currency
21-Jun-2012 BB/B BB/B
The ratings on Russia-based oilfield services company Eurasia Drilling Co. (EDC) reflect Standard & Poor's Ratings Services' assessment of the company's business risk profile as "fair" and its financial risk profile as "significant."
The ratings are constrained by the cyclicality and competitiveness of the oilfield services industry and EDC's dependence on the capital spending of oil and gas companies. Furthermore, EDC has a relatively aged asset base, leading to substantial investment needs, and faces risks from operating in Russia.
The ratings are supported, however, by EDC's long-standing 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 currently favorable market conditions and lower volatility in Russia's oilfield services market than in the global market. Furthermore, EDC is improving the average age of its rig fleet, entering new markets with the acquisition of drilling rigs and crews in Iraq in July 2012, expanding its client base and mix of services, and demonstrating healthy credit metrics.
S&P base-case operating scenario
In our base-case scenario, we anticipate that EDC's revenues will rise by 10%-12% per year on average for the next two years, and could reach about $3.5 billion in 2013. This is primarily thanks to increasing demand for conventional drilling, as well as expansion in the sidetracking segment following the acquisition of assets from the world's largest oilfield services provider Schlumberger Ltd. (A+/Stable/A-1). Sidetracking activity had already quadrupled in the first half of 2012 as compared with the corresponding period of 2011.
We forecast EDC's EBITDA margin to remain healthy at 20%-25%. Our base-case scenario foresees EBITDA increasing further to $700 million in 2012 and to more than $800 million in 2013, compared with $600 million in 2011.
S&P base-case cash flow and capital-structure scenario
Under our scenario, we forecast that in 2012, EDC's adjusted debt-to-EBITDA ratio will stay at 0.5x. Adjusted debt could rise to $370 million in 2012 from $268 million at year-end 2011, following increased financing for the capital expenditures program, but fall thereafter because of a notable increase in EBITDA generation capacity. We therefore forecast that EDC's leverage will fall to about 0.2x in 2013-2014.
We expect slightly negative free operating cash flow of about $15 million in 2012, however increasing up to about $170 million in 2013. This reflects our assumptions of adjusted funds from operations (FFO) of about $550 million-$600 million in 2012 and $650 million-$700 million in 2013, alongside substantial capital spending of about $570 million in 2012 and about $500 million per year afterwards. Dividend payments are expected to be moderate over the next few years.
We forecast that EDC's gross reported debt will be about $580 million-$600 million by the end of 2012 and then decrease to about $370 million-$400 million by year-end 2013, from $753 million as of Dec. 31, 2011.
We assess EDC's liquidity as "adequate," as defined by our criteria. We estimate EDC's ratio of potential sources to potential uses of liquidity at about 1.2x for the 12 months starting July 1, 2012, and at 1.3x for the subsequent 12 months. Liquidity is also supported by the company's prudent risk management and sound relations with Russian banks.
As of July 1, 2012, we estimate EDC's liquidity needs over the following 12 months to be about $750 million, comprising:
-- Debt maturities of about $190 million;
-- Capital expenditures of about $500 million-$550 million;
-- Working capital outflows of about $20 million; and
-- A small acquisition of about $20 million.
We estimate EDC's liquidity sources for the same period to be about $900 million, including:
-- Surplus cash of about $271 million, excluding $50 million of cash that we consider to be tied to the operations; and
-- FFO, which we estimate in our base-case credit scenario at about $600 million-$650 million, factoring in steady EBITDA growth.
EDC is subject to maintenance covenants under several of its bank loan agreements. The strictest of the covenants limit the net debt-to-EBITDA ratio to 2x and the interest coverage ratio to not less than 3x. We consider that 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.
The positive outlook reflects the possibility that we could raise the rating on EDC by one notch over the next 12 months if the company progressed successfully with its expansion plans, resulting in a gradual increase of EBITDA to $700 million-$800 million in 2012-2013 from $600 million in 2011. This also assumes that conditions in the oil field services market in Russia will stay positive over the medium term, supported by continuously high oil prices despite increased global macroeconomic uncertainties.
Any upgrade will also be subject to EDC's ability to maintain what we consider to be satisfactory profitability, with an EBITDA margin in the 20%-25% range. It would also depend on EDC adhering to a prudent financial policy, with an adjusted net debt-to-EBITDA ratio of less than 1.0x under normal conditions, rising temporarily to 1.5x in a downturn.
We could revise the outlook to stable if EDC's liquidity weakened or if the company faced a severe cyclical downturn. We could also revise the outlook to stable if EDC undertook an unexpectedly sizable debt-financed acquisition, leading to adjusted net debt to EBITDA deteriorating to 2x or more, with no near-term prospects for recovery.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008