-- 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.
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.
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.
We assess Key's sources of liquidity as "adequate." Key factors include:
-- $650 million secured credit facility due March 2016 with $550 million
-- 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
-- Expectation that Key will remain in compliance with financial
-- 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.
For the complete recovery analysis, see Standard & Poor's recovery report on
Key Energy Services, published on RatingsDirect on April 25, 2012.
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,
-- 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 Affirmed; Outlook Revised To Positive
Key Energy Services Inc.
Corporate Credit Rating BB-/Positive/-- BB-/Stable/--
Senior Unsecured BB-
Recovery Rating 4