Morningstar DBRS Changes Trend on CES Energy Solutions Corp. to Positive from Stable, Confirms Credit Rating at B (high)

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating of CES Energy Solutions Corp. (CES or the Company) at B (high) and changed the trend to Positive from Stable.

KEY CREDIT RATING CONSIDERATIONS
Despite commodity prices and industry rig count trending lower in 2023 compared with 2022, CES' EBITDA was higher as the Company benefitted from its strong market position, industry trends toward higher service intensity, and higher margins. As a comparison, CES' EBITDA in 2023 was more than double the EBITDA in 2019. Additionally, the Production and Specialty Chemicals segment that typically has more stable and recurring revenue has also grown in lockstep with the drilling fluids business. Consequently, Morningstar DBRS believes the Company is in a better position to manage an industry downturn. The Company also had a working capital surplus of $632.8 million at YE2023, and Morningstar DBRS notes CES has an established track record of monetizing its working capital during periods of lower activity levels with relatively insignificant bad debt expense. Consequently, Morningstar DBRS expects the Company's leverage metrics to remain supportive of the credit rating in the event of a downturn.

The Company generated a material free cash flow (FCF; operating cash flow (OCF) after capital expenditures (capex) and dividends) surplus in 2023. During 2023, CES redeemed its outstanding senior notes by drawing down on its available $250 million Canadian term loan facility and balance drawn from $450 million credit facility. As a result of higher earnings and lower draws on the credit facility, the Company's overall leverage metrics improved substantially in 2023.

CREDIT RATING DRIVERS
Morningstar DBRS may upgrade the credit rating over the next 12 months if CES maintains its market position and growth in earnings in 2024 while maintaining its lease-adjusted debt-to-cash flow ratio at or around 2.5 times. While unlikely, a negative credit rating action would be possible if activity levels and key credit metrics are materially and consistently below Morningstar DBRS' expectations.

EARNINGS OUTLOOK
Based on its base-case crude oil and natural gas price assumptions, Morningstar DBRS expects activity levels in Canada and the U.S. to moderate in 2024 relative to 2023. The inflationary impact on product costs is also likely to moderate in 2024 as supply chain constraints have slightly eased. Morningstar DBRS expects EBITDA in 2024 to be modestly lower compared with 2023. If commodity prices stay above Morningstar DBRS' base-case assumptions, activity levels and consequently EBITDA could exceed its expectations.

FINANCIAL OUTLOOK
Morningstar DBRS expects OCF in 2024 to be modestly lower than in 2023 as a result of lower anticipated earnings. After factoring the Company's budgeted capex ($70 million in 2024) and dividend payments, Morningstar DBRS expects the Company to generate a meaningful FCF surplus in 2024. Morningstar DBRS also anticipates that given the assumption of lower activity levels, the Company will be able to monetize a portion of its working capital surplus. Morningstar DBRS expects the Company to use the FCF surplus and expected working capital inflow to primarily reduce indebtedness under its credit facility and toward shareholder distributions. As a result, overall debt levels are likely to reduce this year. Morningstar DBRS anticipates the Company's key credit metrics to remain relatively unchanged in 2024 as the reduction in overall debt offsets the impact of lower earnings and OCF.

CREDIT RATING RATIONALE
The credit ratings are underpinned by CES' leading market position in Canada, its growing market position in the U.S., and Morningstar DBRS' expectation that the key credit metrics will remain supportive of the credit rating. The Positive trend reflects the step change in the Company's earnings post-COVID-19, which has enhanced CES' ability to withstand market volatility and improved its financial risk profile.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024), https://dbrs.morningstar.com/research/427030.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of CES, the BRA factors are considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of CES, the FRA factors are considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of CES, the BRA and FRA carry approximately equal weight.

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Companies in the Oil and Gas and Oilfield Services Industries (April 15, 2024), https://dbrs.morningstar.com/research/431177

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186, which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

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@morningstar.com.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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