DBRS Morningstar Downgrades Source Energy Services Canada LP and Source Energy Services Canada Holdings Ltd., Places Ratings Under Review with Negative Implications

DBRS Limited (DBRS Morningstar) downgraded Source Energy Services Canada LP and Source Energy Services Canada Holdings Ltd.’s (together, the Co-Issuers) Issuer Rating and Senior Secured First Lien Notes (the Senior Notes) rating to B (low) and B from B and B (high), respectively. The recovery rating on the Senior Notes remains at RR3. DBRS Morningstar also placed the ratings Under Review with Negative Implications. DBRS Morningstar 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 its financial statements are consistent with the financial statements of the Co-Issuers in all material respects.

The rating downgrade follows DBRS Morningstar’s expectation that activity levels in the Western Canadian Sedimentary Basin will remain weak throughout 2020 as oil and gas producers are unlikely to increase spending while market-access issues and regulatory uncertainties persist. Although the Company’s existing contracts, which accounted for 100% of its sales in Q3 2019, should continue to provide a base level of revenues, DBRS Morningstar expects Source’s financial performance in 2020 to be weaker than in 2019 because of weaker product pricing and lack of growth in sales volumes. As a result, the Company’s key credit metrics are expected to weaken and remain well outside the range for the B (low) rating over the next 12 months.

Source’s liquidity position has weakened since DBRS Morningstar’s last review in June 2019. The Company’s primary source of liquidity is its asset-backed credit facility (Credit Facility) maturing in December 2021. Availability under the Credit Facility is subject to a borrowing base ($46.5 million at September 30, 2019) determined on a monthly basis based on accounts receivable and inventories. As at September 30, 2019, Source had drawn $22.2 million under the Credit Facility and issued $18.1 million in letters of credit, leaving the Company $6.2 million of available liquidity. While Source was expected to draw on its Credit Facility in 2019 to fund its projected free cash flow deficit, the magnitude of the deficit was larger than expected primarily because of the $13.9 million recovery, clean-up and initial capital costs associated with an accident at its Fox Creek terminal in May 2019. DBRS Morningstar also notes that the Credit Facility is subject to a minimum fixed charge coverage ratio (FCCR) of 1.25 times (x) when availability is less than 20% of the lesser of the borrowing base or Credit Facility. The Company was marginally compliant with the covenant at September 30, 2019, with a FCRR of 1.26x.

Source is in discussions with its syndicate of lenders to request some flexibility in its FCCR over the next 12 months. The Company received interim insurance proceeds of $2.6 million in October 2019 for the Fox Creek incident and expects to receive the balance in late 2019 or early 2020. DBRS Morningstar considers the covenant flexibility and receipt of the remaining insurance proceeds as material to the Company’s liquidity position and, as a result, placed Source’s ratings Under Review with Negative Implications until these issues are resolved satisfactorily. The receipt of the insurance proceeds and covenant flexibility should provide the Company with some headroom; however, given the expectation of weaker cash flow in 2020 and Source’s high interest and operating lease payments (approximately $45.0 million in FY2020), DBRS Morningstar expects liquidity to remain a concern over the next 12 months. DBRS Morningstar will review further information, as it becomes available, with respect to the outcome of Source’s discussions with its lenders and the status of the remaining insurance proceeds to resolve the Under Review status over the next three months.

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 [email protected].

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

For more information on this credit or on this industry, visit www.dbrs.com or contact us at [email protected].

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