DBRS Assigns an Issuer Rating of B and a Provisional Senior Secured First Lien Notes Rating of B (high) to Source Energy Services Canada LP and Source Energy Services Canada Holdings Ltd.

DBRS Limited (DBRS) assigned an Issuer Rating of B to Source Energy Services Canada LP and Source Energy Services Canada Holdings Ltd. (together, the Co-Issuers). DBRS has also assigned a provisional rating of B (high) with a Recovery Rating of RR3 to the Senior Secured First Lien Notes (the Senior Notes) issued by the Co-Issuers. All trends are Stable. DBRS has based its analysis on the consolidated financial statements of the ultimate holding company, Source Energy Services Limited (SES or the Company). SES has no material assets, liabilities, revenues or expenses of its own other than the shares held by it in the capital of its subsidiaries and is consistent in all material respects with the financial statements of the Co-Issuers.

SES is the largest supplier of northern white frac sand to oil and gas (O&G) companies drilling in the Western Canadian Sedimentary Basin (WCSB). SES’s ratings are underpinned by its fully integrated operations with market-leading logistics infrastructure and its established customer relationships with contracted sales volumes, coupled with favourable industry trends. Key challenges to the ratings include the Company’s relatively small size, the cyclical nature of its end-use markets and a lack of geographical and product diversification.

Northern white frac sand is the preferred proppant used for hydraulic fracturing in the WCSB. The Company owns and operates processing facilities, including mines in Wisconsin and the largest terminal network and storage capacity in the WCSB, which are all located on the Canadian National Railway Company’s (rated “A” with a Stable trend by DBRS) rail network. This provides SES with a competitive advantage, as most of the frac sand used in the WCSB is shipped from Wisconsin, and approximately 70% of the in-basin landed cost consists of freight costs. SES also sells a significant amount of its output (approximately 75%) under contracts, which provides near-term sales volume visibility. Although most of the contracts do not stipulate minimum volumes, the counterparties are some of the largest frac sand consumers in the Montney Formation, whose drilling and completion programs were active through the downturn. DBRS notes that the liquids rich Montney resource play is one of the lowest cost plays in North America and has driven Canadian demand for frac sand. The contracts also permit SES to sell most of its volumes in-basin or at the well site, allowing it to capture additional value from its logistics infrastructure. Furthermore, SES benefits from the trend toward higher frac sand intensity per well, as O&G producers drill longer reach horizontal wells with increased fracturing stages to achieve higher flow rates.

Although the Company is the leading player in Canada, the smaller size of the Canadian frac sand market compared with the United States makes SES a relatively smaller player versus its U.S. peers. The financial performance of the Company is highly correlated to the prevailing outlook for O&G prices, which in turn are volatile. Although the Company’s sales contracts provide some volume and price protection, they do not insulate the Company from a prolonged slump in O&G prices as seen during 2015 and 2016. SES’s exclusive focus on Canada makes it vulnerable to localized risks like seasonality, and its single-product offering could potentially expose the Company to replacement risk in the longer term.

The Senior Notes are secured by a second charge on accounts receivable and inventories and a first charge on all other assets of the Company. The Company’s Asset-Backed Credit Facility (Credit Facility) has a first charge on the account receivables and inventory and second charge on all other assets of the Company. SES proposes to issue an additional $40 million of Senior Notes with the same terms and conditions as the existing Senior Notes and use the proceeds to repay borrowings under its Credit Facility. DBRS expects the Credit Facility to provide the Company with a satisfactory liquidity buffer over the next 12 months.

DBRS expects the Company’s earnings and cash flow to increase materially in 2018 due to higher sales volumes and stronger product pricing as evidenced by the results for the quarter-ended March 31, 2018. The Company’s key credit metrics continue to improve, and for the last 12 months ended March 31, 2018, the key lease-adjusted credit metrics (debt-to-cash flow: 4.91times (x); EBIT interest coverage: 1.89x; debt-to-capital: 49%) are within the B rating range. Debt levels are expected to remain relatively flat, as the Company is expected to generate adequate cash flow to meet a large part of its budgeted capital expenditure. DBRS expects key credit metrics to remain supportive of the current rating over the next 12 months.

DBRS may consider a rating upgrade if SES is able to maintain its key credit metrics consistently in the BB rating range while retaining or improving its competitive advantage. Conversely, if the key credit metrics deteriorate significantly from their current levels, possibly due to another significant industry downturn, or if the business strengths underpinning the rating are materially weakened, DBRS may consider a ratings downgrade.

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

The principal methodologies are Rating Companies in the Oil and Gas and Oilfield Services Industries and DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers, which can be found on dbrs.com under Methodologies.

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 under Related Documents or by contacting us at info@dbrs.com.

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

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