DBRS Downgrades Savanna Energy Services Corp. to B

DBRS Limited (DBRS) has today downgraded the Issuer Rating and the rating of the $175 million Senior Unsecured Notes (the Notes) of Savanna Energy Services Corp. (Savanna or the Company) to B from B (high), and has maintained the trends at Negative. The Recovery Rating of the Notes remains unchanged at RR4. The ratings downgrade reflects the expected continued deterioration of the Company’s key credit metrics with no meaningful recovery expected within the next 12 months given the challenging market conditions, despite the significant balance sheet preservation initiatives to-date. The current B rating also reflects the heightened refinancing risk of the Notes under a prolonged, weak market environment.

On February 11, 2015, DBRS changed the trend of Savanna to Negative and noted that “should Savanna’s key credit metrics deteriorate materially beyond current rating parameters without any material improvements expected over time and/or fail to resolve its covenant breach risk, this could lead to further negative rating actions”. In April 2015, Savanna amended certain financial covenants under its senior secured revolving credit facility (the Credit Facility) which alleviated the covenant breach risk and provided the Company with greater covenant flexibility going forward. In the nine months ended September 30, 2015 (9M 2015), the Company also undertook significant balance sheet preservation initiatives to mitigate against the expected weak market conditions on its financial profile. These initiatives included: (1) substantial reduction of operating and general and administrative costs, which improved margins year-over-year despite pricing pressures from customers, (2) elimination of the dividend program in Q1 2015 ($24 million paid in 2014), (3) curtailment of capital expenditures (capex) (2015 budget of $58 million versus $247 million in 2014), (4) disposition of non-operating assets ($30 million expected by year-end 2015), and (5) reduction of debt outstanding ($312 million in 9M 2015 versus $351 million in 2014).

However, notwithstanding these initiatives, the Company’s key credit metrics have still weakened significantly in 9M 2015, primarily because of low market activity. In 9M 2015, the utilization rate of Savanna’s contract drilling rigs and well servicing rigs decreased year-over-year to 23% from 57%, and to 38% from 51%, respectively. This decline in market activity has resulted in a significant year-over-year reduction in revenue (41%), EBITDA (25%) and operating cash flows (34%). DBRS believes that a material improvement in the key credit metrics remains unlikely over the next 12 months given the challenging market outlook in 2016, which could lead to further weakness in Savanna’s financial profile. Activity during the 2015/2016 winter drilling season in Canada is expected to be muted, with uncertainty post-spring breakup in 2016. Utilization is also expected to be very low in the United States, where activity is mainly supported by current contracts in place. The low utilization rates in North America, albeit partially offset by the mostly contracted assets in Australia, could continue to constrain earnings and operating cash flow over the near term, limiting any significant improvements in the Company’s financial profile. DBRS recognizes that these negative pressures are expected to be partially offset by the minimal level of funding requirements going forward for capex (maintenance capex of $17 million in 2015, with all growth capex competed in 9M 2015) and dividends (eliminated in Q1 2015), which should allow the Company to partially reduce the level of debt outstanding with positive free cash flow. However, continued weakness in earnings and operating cash flow is expected to more than offset the expected reduction in debt for the Company’s key credit metrics.

DBRS also views that the refinancing risk of the Notes has heightened amidst the current weak commodity pricing environment. The Notes mature in May 2018; however, the $250 million Credit Facility will mature in January 2018 if the Notes are not repaid or refinanced on terms acceptable to the lenders. Should market conditions remain weak through 2016 and beyond, it could be increasingly challenging for Savanna to refinance the Notes. As a result, the Company will become more reliant on the Credit Facility as a refinancing alternative. In DBRS’s view, with this heightened refinancing risk, combined with potential further weakness in the key credit metrics, Savanna’s risk profile is no longer commensurate with a B (high) rating.

The Negative trend reflects DBRS’s concerns for the increasing refinancing risk and potential further weakness in the key credit metrics beyond the next 12 months should market activity levels remain depressed without any outlook improvements, which could lead to further negative rating action. The trend may be changed to Stable if market activity outlook improves for 2016 and beyond and/or the Company further reduces its leverage significantly to stabilize its key credit metrics at a level that is commensurate with the current rating range.

Savanna’s liquidity is expected to remain manageable to fund near-term capex and operations. Liquidity is supported by its $250 million Credit Facility ($117.3 million drawn as of November 2, 2015), which could mature as early as January 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.