DBRS Downgrades Newalta Corporation and Maintains Negative Trend

DBRS Limited (DBRS) has today downgraded the Issuer Rating of Newalta Corporation (Newalta or the Company) to B from BB (low). The Company’s Recovery Rating is downgraded to RR6 (Poor) from RR5, based on an anticipated debt recovery of less than 10% in a hypothetical default scenario. This results in a two-notch adjustment to arrive at an Unsecured Notes rating of CCC (high), which is defined as “Very Highly Speculative Credit Quality.” (Please refer to “Long-Term Obligations Rating Scale” under the Rating Scales section of the DBRS web site.) The trends remain Negative.

Results in Q4 2015 were again below DBRS’s expectations, and the outlook for 2016 has weakened further. In November 2015, DBRS noted that the Company had little cushion to absorb further weakening of the financial risk profile, and that DBRS may take another negative rating action if disappointing operating performance continues to weaken the Company’s key credit metrics. As a result of the poor operating results, actual credit metrics for 2015 were below DBRS’s projections, as stated in November 2015. Adjusted debt-to-EBITDA rose to 6.0x (DBRS’s previous projection: 4.8x) and adjusted cash flow-to-debt fell to 3.7% (projected at 10%). These key metrics fall well below the BB category ranges, as described in DBRS’s “Rating Companies in the Industrial Products Industry” methodology (June 2015), available on the DBRS web site.

Since DBRS downgraded Newalta’s ratings in November 2015, the operating environment has continued to weaken. Oil prices have continued to fall, with the WTI benchmark dropping well below $40/barrel in December 2015 (and subsequently breaching below $30/barrel in Q1 2016). Newalta’s performance continued to decline, with the same challenges buffeting results: (1) reduced drilling and production activities in the oil patch; (2) customer curtailments, delays, and cancellations of capital expenditures; (3) additional well shutdowns, and the associated reduction of production-related waste volumes; (4) lower quality waste volumes available (i.e., less oil content); and (5) greater price competition for increasingly scarce waste volumes.

DBRS acknowledges the substantial efforts made and progress achieved by the Company to reduce its annual run-rate costs ($40 million in 2015; expecting a further $10 million in 2016) and bolster its liquidity position (cessation of dividends; substantially reduced capex). Newalta has also secured further accommodations from its secured credit facility lending group, with the debt-to-EBITDA covenant waiver extended through Q1 2018 (previously through Q2 2017), and the thresholds for the Interest Coverage and Senior Debt covenants relaxed. In addition, the total amount available has been reduced to $160 million from $175 million, with $97 million available as at December 31, 2015.

Despite these significant actions taken to improve the Company’s ability to operate under severely challenging conditions, the impact on the financial profile is material, and the outlook is unfavourable. DBRS believes it will be challenging for the Company to achieve EBITDA in 2016 above the low end of its projected range ($25 million to $45 million), although DBRS notes that the forecast is based on a relatively conservative WTI spot oil price range assumption of USD 25 to 35 per barrel. Given Newalta’s projected free cash flow deficit in 2016, the financial profile is expected to deteriorate further in 2016, and the current liquidity position is stressed. Total liquidity as at December 31, 2015, was $98 million, consisting almost entirely of availability under the credit facility. Should operating performance come in at the low end of the projected range, the deterioration in the financial profile would be substantial.

At this stage, further cost reductions will be increasingly difficult for Newalta to achieve after the substantial efforts made thus far. Therefore, its ability to strengthen its liquidity position and financial profile depends heavily on market conditions.

The Negative trend reflects the stretched financial profile, the unfavourable market outlook, the increasing difficulty that would be associated with any future cost cutting initiatives and the expectation of a free cash flow deficit in 2016. DBRS will be closely monitoring Newalta’s liquidity position and operating performance in the coming quarters. Cash burn at a faster pace than expected and/or further disappointments in operating results may lead to an additional negative rating action.

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.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.