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 CCC (high) from B. The Company’s Recovery Rating remains unchanged at RR6 (poor) based on an anticipated unsecured 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 (low). The trends remain Negative.

DBRS noted in its August 4, 2016, comment on Newalta’s Q2 2016 results that further deterioration in operating results could lead to additional downgrades. Based on the announcement on November 9, 2016, operating performance in Q3 2016 was indeed once again materially weaker on a year-over-year (YOY) basis, and the Company reduced the upper end of its full-year 2016 EBITDA guidance, although notable sequential improvement was achieved. In addition to the ongoing challenges associated with reduced customer activity in response to the lower oil price environment, heavy rains affected results in Q3 2016, although not to the same degree as the fires at Fort McMurray in Q2 2016. Overall, revenues fell by 39% YOY, although they were up by 23% versus the weak Q2 2016 result. During Q3 2016, a free cash flow deficit was financed with an additional $11 million drawn on the Senior Secured Credit Facility, bringing total balance sheet debt to $317 million. On a last 12 months’ (LTM) basis, key financial metrics have weakened further beyond the current rating range. Operating cash flow was negative, and debt to EBITDA rose to 23 times (x). EBITDA fell to only 0.6x interest, while debt in the capital structure remained elevated at over 50%. Note that all DBRS metric calculations include adjustments for operating leases.

Despite the significant strain on the Company’s credit metrics, Newalta remained compliant with its only active credit facility covenant in Q3 2016 after choosing Q3 2016 as the quarter in which to exercise its EBITDA-to-interest covenant waiver, an accommodation granted previously from the lending syndicate. The Company avoided breaching the minimum 1.00:1 threshold, as this metric was 0.89x in Q3 2016. Newalta received an additional precautionary waiver for this covenant for Q4 2016. As per the covenant calculations (which differ from DBRS’s methods), senior debt to LTM EBITDA was 3.29x versus the 6.50x limit. The total-debt-to-EBITDA covenant remains waived through Q1 2018. The Company has also remained compliant with the covenants and restrictions associated with its unsecured debentures.

While the weakening of the financial metrics is substantial and a cause for concern, liquidity remains adequate. Newalta’s Senior Secured Credit Facility matures in July 2018 and can be extended on an annual basis, subject to the approval of the lending syndicate. As at September 30, 2016, $45 million was drawn. On October 31, 2016, the principal borrowing amount was reduced by $10 million to $150 million, which leaves the Company with total liquidity of $84 million using the September 30, 2016, reported drawings; the small amount of cash on the balance sheet; and after adjusting for the portion supporting $22 million in letters of credit. DBRS projects that Newalta will again post a free cash flow deficit in 2017, but the drawings required to finance this will likely be modest, assuming the continuation of substantially reduced capital spending compared with historical levels and that the dividend suspension through at least March 2018 remains in place.

Newalta’s current financial profile, based on its key credit metrics through the LTM ended September 2016, is inconsistent with even the downgraded ratings. However, some of its key business strengths, such as its technical capacities, good reputation among customers and lower operating cost structure following a major push to drive down expenses, remain intact. Market conditions remain challenging, the oil price outlook is tepid and visibility regarding revenues and cash flows is poor, all of which factor into the maintenance of the Negative trend. However, should Newalta continue the performance achieved in Q3 2016 (excluding the impact of the heavy rains) into subsequent quarters, projected activity should be sufficient for Newalta to achieve material improvement compared with its recent very weak performance. Under such a scenario, financial metrics would recover strongly into 2017, albeit from a particularly weak base, and DBRS would likely consider changing the trend to Stable. In lieu of any additional exogenous shocks during this timeframe, operating conditions could possibly enable Newalta to begin generating free cash flow and to make modest debt-reduction payments in 2018. If Newalta is unable to sustain the performance achieved in Q3 2016, DBRS will likely consider an additional downgrade.

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.

The applicable methodologies are Rating Companies in the Services Industry (March 2016) and DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers (March 2016), which can be found on our website under Methodologies.