DBRS Upgrades Newalta Corporation to BB, Trend Stable

DBRS has today upgraded the Issuer Rating of Newalta Corporation (Newalta or the Company) to BB from BB (low) and changed the trend to Stable from Positive. The rating action recognizes Newalta’s improving business profile, a growing on-site contract business that is more stable and with a multi-year term and strengthening financial profile. Pursuant to “DBRS Criteria: Rating Leveraged Finance,” DBRS has confirmed the recovery rating of the Unsecured Notes at RR4. Correspondingly, the Unsecured Notes rating is upgraded to BB from BB (low) as a result of the upgrade to the Issuer Rating. The trend is Stable.

The Company has made good progress in executing its business strategies. Strong drilling activities in the oil field and improving industrial activities have enabled Newalta to boost the utilization rate of its equipment. In addition, the higher industry activity levels have also helped the Company expand its drill-site fleet. More importantly, the Company has been very successful in growing its on-site contract business. Converting on-site projects, which are non-recurring and seasonal with terms of less than one year, to contracts that are generally year-round and with terms longer than one year will help stabilize Newalta’s overall performance. In addition, the stronger bond with contract customers is much more difficult for competitors to overcome and, hence, help to entrench the Company’s market position. Furthermore, on-site contracts tend to base on fee for service solution with not direct commodity price exposure. This type of contract reduces earnings risk and volatility. Higher mix of the more stable on-site contract works coupled with the improved operating efficiency and equipment utilization has strengthened Newalta’s business profile.

Newalta had a very strong 2011, with all businesses reporting meaningful year-over-year improvement. High activity levels in all sectors and geographical regions, stronger equipment utilization rates and favourable commodity prices all contributed to a sharp increase in earnings. An acute ramp-up on growth spending has led to a deficit in free cash flow, despite strong internal cash generation. Nevertheless, Newalta’s strong operating results were still able to support credit metrics at favourable levels despite the higher debt levels. In the first half of 2012, operations still reported better year-over-year results, supported by continuing favourable market conditions and utilization rate partly offset by lower commodity (crude oil and lead) prices. Again, continuing high growth capital spending, primarily related to contract work in the Heavy Oil segment, has exceeded internal cash generation resulting in more debt. The steady increase in debt levels has finally weakened the debt coverage ratios despite a modest improvement in operating results. Nevertheless, the recently announced equity issuance, gross proceeds of at least $70 million, helps offset the moderate deterioration in the balance sheet. The Company’s strengthened financial profile provides solid support to the upgrade. In addition, the transaction also demonstrates Newalta’s commitment to maintaining a moderate financial profile.

Overall, the Company’s near-term outlook is still positive, although market conditions are mixed among the business segments. Low natural gas prices have led to a slowdown in drilling activities, which may impede the Company’s drill-site activities and equipment utilization rate, and commodity (crude oil and lead) prices remained under pressure. However, industrial activities are expected to remain favourable, and increasing demand for the Company’s services, particularly in the Eastern region, bodes well for stronger earnings in the Facilities business. Furthermore, the Company also anticipates increased project and contract activities in the Heavy Oil segment and in the United States, which should maintain the strong momentum in the Onsite business. The Company anticipates a strong H2 2012 performance, maintaining the growth trend in earnings. Furthermore, DBRS expects the successful execution of the on-site contracts should add to earnings and associated cash flow generation in 2013, which should remain favourable.

Pursuant to our rating methodology for leveraged finance, DBRS has created a default scenario for Newalta in order to analyze when and under what circumstances a default could hypothetically occur and the potential recovery of the Company’s debt in the event of such default. DBRS has determined Newalta’s estimated value at default using an EBITDA multiple valuation approach at approximately $360 million, using a 4.0x multiple of normalized EBITDA. Based on the default scenario, the Unsecured Notes would have recovery estimated between 30% and 50%, which aligns with a recovery rating of RR4. Therefore, the instrument rating of the Unsecured Notes is BB, the same as the Issuer Rating.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodologies are Rating Companies in the Industrial Products Industry (June 2011) and DBRS Criteria: Rating Leveraged Finance (June 2011), which can be found on our website under Methodologies.