DBRS Confirms Newalta Corporation and Changes Trend to Positive

DBRS Limited (DBRS) confirmed the Issuer Rating of Newalta Corporation (Newalta or the Company) at CCC (high) and the Company’s Unsecured Notes rating at CCC (low). However, DBRS is changing the trend on both ratings to Positive from Stable as a result of recent moderately positive operating results consistent with DBRS’s expectations of improved performance, and a business risk and financial risk profile which exceeds levels commensurate with the current ratings. The Company’s Recovery Rating remains unchanged at RR6 based on an anticipated unsecured debt recovery of less than 10% in a hypothetical default scenario. The RR6 rating results in a downward two-notch adjustment to arrive at the Unsecured Notes rating of CCC (low).

When Newalta’s trends were changed to Stable from Negative on May 18, 2017, DBRS noted that the recent favourable developments in the operating environment could be a harbinger of a sustainable recovery. If so, DBRS stated that a positive rating action could be considered.

Triggered by the dramatic decline in oil prices starting in late 2014, drilling activity, which is a key driver of Newalta’s business, fell precipitously in 2015 by approximately 50%, and again in 2016 by an additional approximately 25%. In lockstep, utilization of Newalta’s drill site equipment dropped from a normalized rate of over 50% to 27% in 2015 and only 16% in 2016, including a very low 8% in Canada. Quarterly drilling activity finally began to improve, albeit compared with a low base, in Q1 2017. On a year-over-year basis, drilling activity rose by 35% in Q1 2017, by 30% in Q2 2017 and by 32% in Q3 2017. This activity was supported by a more favourable oil price environment, with the WTI spot price averaging approximately USD 49/barrel (bbl) in the 9M 2017 period compared with approximately USD 41/bbl in the same period of 2016. Newalta was significantly challenged by having the majority of its equipment sitting idle in 2016. However, DBRS noted that utilization recovered in Q1 2017 to 37%. Since then, drill site utilization has continued to improve (38% in Q2 2017; 43% in Q3 2017), indicating some traction in the overall operating environment recovery.

Furthermore, DBRS also noted in May 2017 that continuation of the trend of clients undertaking deeper depth drilling, would be favourable. In 2017, the number of metres drilled per month in the Western Canadian Sedimentary Basin has tracked well ahead of 2016, reaching over two million metres in certain months. In addition, the average depth per well continues to increase.

As a result, Newalta has achieved a last 12 months (LTM) EBITDA performance of $45.3 million through Q3 2017. This compares with $18 million in F2016, an amount that was also depressed by the impact of the fires in Fort McMurray in Q2 2016 and road restrictions caused by heavy rainfall in Q3 2016. This latest performance is consistent with DBRS’s expectations under a scenario in which the initial signs of recovery in Q1 2017 gained some traction.

As a result of the operating performance, although somewhat mitigated by the modest additional debt funding of negative free cash flow, Newalta’s key financial metrics have all improved compared with LTM Q1 2017 (the basis of DBRS’s previous rating action) and are now all in the B category range. Adjusted cash flow-to-debt in LTM Q3 2017 was 1.6%; adjusted debt-to-EBITDA was 7.52 times; and adjusted EBITDA interest coverage was 1.84 times. DBRS projects that, absent exogenous shocks, including another negative oil price shock and the associated reduction in drilling activity, these financial metrics should remain roughly stable as Newalta works toward the achievement of a free cash flow breakeven position. DBRS does not project this happening until 2019 at the earliest and anticipates that Newalta will continue to modestly draw on its credit facility in the interim. Modest improvements in EBITDA and operating cash flows should mitigate the impact of the additional debt.

Newalta’s $150 million total secured credit facility is due to mature on July 12, 2019, and is generally extended on an annual basis. As of September 30, 2017, Newalta was in compliance with all applicable debt covenants and had $60.2 million available under this facility. Although the Company held no cash on the balance sheet, the liquidity available under the facility remains sufficient to meet near-term requirements.

Newalta’s next long-term debt maturity is in November 2019 when its $125 million Series 2 Senior Unsecured Debentures are due. On November 14, 2017, these bonds will enter a par call period, and the Company has “a number of options under consideration that are consistent with their focus on optimizing their capital structure.”

Given that Newalta’s business risk profile and key financial risk metrics would support a higher Issuer Rating, DBRS would consider an upgrade with further evidence of the robustness of the recovery in Newalta’s operating environment over the coming quarters, along with a successful refinancing of the Company’s 7.75% Series 2 Senior Unsecured Debentures, which mature in November 2019. This guidance notwithstanding, DBRS notes that the current rating remains Very Highly Speculative and cautions that the Company’s financial position remains strained, exposure to the volatile Oil & Gas sector remains a key driver, and the Company continues to operate from a free cash flow deficit position. Any material departure from the current operating trajectory, or an inability to successfully refinance the 2019 Debentures could result in a 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.

The principal 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 dbrs.com under Methodologies.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.