DBRS Confirms Newalta Corporation at BB with a Stable Trend

DBRS Limited (DBRS) has today confirmed the Issuer Rating of Newalta Corporation (Newalta or the Company) at BB with a Stable trend following the Company’s announcement on February 27, 2015, of the completion of the sale of the Industrial Division (Industrial) for $300 million in cash plus the assumption of certain decommissioning liabilities to Revolution Acquisition LP, a Birch Hill Equity Partners company. In addition, DBRS has confirmed the recovery rating at RR4 and, as a result, the Unsecured Notes rating at BB with a Stable trend.

The confirmation reflects that the Company’s risk profile (business risk and financial risk), albeit weakened after the sale, remains compatible with the current rating. DBRS notes that the Company’s financial profile still has a limited cushion to absorb a modest decline in operating performance in 2015 and still be within the current rating range. Hence, DBRS expects the ratings to remain stable in the near future. With this rating action, Newalta is removed from Under Review with Developing Implications where it was placed on December 24, 2014.

DBRS notes that the sale of the Industrial Division (Industrial) has weakened the Company’s business risk profile. The Company will be smaller and less diversified (both in business lines and geography) and will be fully exposed to the oil and gas industry. Increased sensitivity to volatile crude oil prices and oil patch activities will lead to a less stable financial profile and higher associated business risks. In addition, the Company will lose one of its strengths (the extensive list of regulatory permits across Canada) which is difficult to duplicate. Nevertheless, DBRS notes that the remaining New Market and Oilfield Divisions have good growth opportunities and higher margins. In addition, the growing on-site contracts at the Heavy Oil segment also help improve revenue and earnings visibility and moderate the volatility associated with the oil and gas industry. In sum, revenue and earnings will shrink initially after the sale but margins will improve. Furthermore, the Company has announced a number of cost reduction and rationalization initiatives to maximize business efficiencies. Benefits from these initiatives will add to earnings and margins. Hence, the Company’s business risk profile, although weakened, remains acceptable but at the lower end of the current rating range.

The Company has also indicated in its initial sale announcement that it intends to use part of the proceeds for debt reduction. On a pro forma basis, the Company’s debt coverage metrics would be strengthened meaningfully, well above the current rating range, if borrowings from the secured credit facilities ($183.1 million at the end of 2014) are repaid. This deleveraging action would help to reduce the Company’s financial risks especially under the current depressed conditions in the oil and gas industry.

In the near term, the sharp decline in crude oil prices and the resultant sharp reduction in drilling activities would impact operating performance. DBRS expects a modest decline in earnings and internal cash generation at Newalta in 2015. Even though the Company has flexibility to adjust capital spending in relation to market conditions, DBRS expects the Company to incur a modest deficit in free cash flow despite lower capital expenditures. Nevertheless, the Company’s financial risk profile, although weakened, would remain acceptable to the current rating. Longer term, the Company is well positioned to benefit from the recovery in the oil and gas sector. In addition, DBRS expects Newalta to maintain a stronger financial profile to offset the weaker business risk profile to remain compatible with the current rating.

DBRS expects the ratings to remain stable in the near future. DBRS may consider taking positive rating actions if the Company could achieve strong growth especially in its more stable onsite contracts and meaningfully strengthen its business profile. Conversely, DBRS may take negative rating action, if the Company’s financial profile weakens sharply because of persistent deterioration in its operating results or a large debt-financed acquisition, although none is contemplated at this time.

Pursuant to DBRS’s rating criteria on recovery ratings for non-investment grade corporate issuers, 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, using a 4.0x multiple of normalized EBITDA. Based on the default scenario, the Unsecured Notes would have recovery estimated between 30% and 60%, 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 related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodologies are Rating Companies in the Services Industry and DBRS Criteria: DBRS Recovery Ratings for Non-Investment Grade Corporate Issues, which can be found on our website under Methodologies.