DBRS Confirms Canadian Energy Services & Technology Corp. at B (high), Trends Remain Negative

DBRS Limited (DBRS) has today confirmed the Issuer Rating and the Senior Unsecured Notes rating (the Notes) of Canadian Energy Services & Technology Corp. (CES or the Company) at B (high) and maintained the trends at Negative. The recovery rating for the Notes remains unchanged at RR4. The confirmations reflect: (1) CES’s business risk profile remaining supportive of the current rating category, underpinned by continued growth in the Production and Specialty Chemical segment (Production and Specialty Chemical); (2) reasonable key credit metrics, although at the low end for the rating range; and (3) an adequate liquidity position with manageable refinancing risk over the next 24 months. The Negative trend reflects the significant, ongoing challenges of a low commodity pricing environment on market activity and pricing across all business segments, but to a greater extent for the Drilling Fluids segment (Drilling Fluids), and concerns of continued deterioration of CES’s key credit metrics to levels materially beyond the current rating on a prolonged basis.

CES’s business risk profile remains supportive of the B (high) rating as the Company continued to experience organic growth in Production and Specialty Chemicals in both Canada and the United States despite the weak commodity pricing environment in 2015. Growth over the past couple years have been driven by the successful integration of a number of acquisitions, most notably JACAM Chemical Company, Inc. in 2013. Production and Specialty Chemicals benefits from relatively more stable demand and stronger margins compared to Drilling Fluids. Going forward, DBRS expects that Production and Specialty Chemicals will account for an increasing proportion of CES’s consolidated earnings and operating cash flow. The Company’s size and scale, and moderately flexible capital expenditure (capex) profile also remain supportive of the current rating. As such, DBRS expects CES’s business risk profile to remain commensurate with the B (high) rating.

On February 11, 2015, DBRS changed the trends on CES’s Issuer Rating and the Notes to Negative to reflect concerns of a material deterioration of CES’s financial profile beyond the current rating parameters, given the low commodity environment. For the nine months ended September 30, 2015 (9M 2015), CES’s key credit metrics have weakened, driven by a significant decline in market activity and ongoing pricing pressures on margins, particularly from Drilling Fluids. Operating cash flows and EBITDA declined 22% and 36%, respectively, year over year, while EBITDA margins declined to 14% from 19%. These negative drivers were partially offset by continued market share growth in Production and Specialty Chemicals, a stronger USD exchange rate combined with increasing earnings contributions from the U.S. and a reduction of debt as the Company converted a significant amount of working capital into cash in the low activity environment ($313 million of total debt outstanding at 9M 2015 versus $376 million in 2014). As a result, despite weakening over the past 12 months, CES’s key credit metrics are currently still supportive of the B (high) rating, although they are now on the low end of the rating range.

However, CES’s financial profile remains vulnerable as reflected by the Negative trend, particularly if the weak commodity pricing environment were to extend through 2016. Under a continued low commodity pricing environment, drilling activity and margins are expected to remain weak in North America, which will likely result in a continued deterioration of operating cash flows, particularly for Drilling Fluids. Continued growth in Production and Specialty Chemicals going forward could partially offset this negative pressure. Nonetheless, with a dividend payout ratio (71% as a percentage of operating cash flows in 9M 2015) that is high, the Company will likely generate a significant free cash flow deficit, assuming capex and dividends remain in line with 2015 levels. DBRS recognizes that there is flexibility in CES’s expansionary capex program that could reduce the funding pressure on its balance sheet. Notwithstanding the expectation of further capex curtailment under weak market conditions, should CES’s key credit metrics deteriorate beyond the current rating range with no improvements expected over time, this could lead to a rating downgrade. CES’s trends may be changed to Stable if the magnitude of the expected free cash flow deficits are reduced significantly going forward, leading to an improved outlook on credit metrics to a level that is commensurate with the rating. This can potentially be achieved through significant capex and dividend curtailment and/or sustained improvement in market activity and margins.

CES’s liquidity position is expected to remain adequate to fund near-term capex and operations (including working capital). Liquidity is supported by a $200 million senior credit facility (undrawn as of September 30, 2015) and $21 million of cash on hand. Refinancing risk is manageable as the Notes do not mature until April 2020, while the credit facility does not mature until September 2018.

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 applicable methodologies are Rating Companies in the Oilfield Services Industry and DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers, which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.