DBRS Changes Trend on Source Energy Services Canada LP and Source Energy Services Canada Holdings Ltd. to Negative

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

The Co-Issuers’ ratings are underpinned by Source’s fully integrated operations with market-leading logistics infrastructure and its established customer relationships with contracted sales volumes, coupled with an industry trend toward higher proppant intensity. Key factors moderating the ratings include the Company’s relatively small size, the cyclical nature of its end-use markets, weaker credit metrics and lack of geographical and product diversification. The change in trend acknowledges the deterioration in the Company’s key credit metrics and is reflective of DBRS’s opinion that the outlook for drilling and completion in the Western Canadian Sedimentary Basin (WCSB) remains muted in 2019 with a high degree of uncertainty thereafter.

While the Company has improved its contract profile with the addition of three new customers under multi-year contracts, DBRS expects overall sales volumes in 2019 to be lower due to weaker non-contracted sales volumes, as activity levels in the WCSB are expected to be lower. Beyond 2019, oil and gas producers are unlikely to increase spending materially until there is greater visibility on pipeline take-away capacity, provincial curtailment in Alberta and government policy changes.

Over the last six months, lower earnings due to weaker activity levels and higher debt as a result of free cash flow deficits have resulted in a material deterioration of Source’s key credit metrics. Source’s lease-adjusted debt-to-cash flow and EBIT interest coverage ratios for the last 12 months ended March 31, 2019, are below the threshold for the current rating (7.35 times (x) and 0.54x, respectively). DBRS expects the credit metrics to weaken further in 2019 due to weaker earnings and higher debt. However, DBRS does note that given the Company’s predominantly variable cost base and low maintenance capex, any marginal improvement in product pricing beyond DBRS’s base case assumptions could lead to a material improvement in the key credit metrics. While the Company is expected to draw on its asset-backed credit facility in 2019 to fund an expected free cash flow deficit, DBRS believes the Company should have adequate liquidity over the next 12 months to meet its obligations. However, if activity levels track materially lower than DBRS’s base case assumptions, the Company’s liquidity could come under pressure.

A negative rating action is likely if the outlook for activity levels remains unchanged over the next 12 months and/or if there is a material deterioration in financial performance in the interim. Conversely, if the key credit metrics improve with a positive outlook for drilling and completion activity beyond 2019, DBRS may change the trend back to Stable.

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, DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers, DBRS Criteria: Rating Corporate Holding Companies and Their Subsidiaries and DBRS Criteria: Guarantees and Other Forms of Support, which can be found on dbrs.com under Methodologies & Criteria.

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.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.

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

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada