-- 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.
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.
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
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.
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
-- 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.
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.)
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
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