S&P Lowers Outlook on Precision Drilling (PDS) to Negative; Sees Industry Conditions Remaining Weak

Standard & Poor's Ratings Services today said it revised its outlook on Precision Drilling Corp. (NYSE: PDS) to negative from stable. At the same time, Standard & Poor's affirmed its 'BB+' long-term corporate credit and 'BB' unsecured debt ratings on Precision. The '5' recovery rating on the debt is unchanged, and reflects our expectation of modest (10%-30%; in the upper half of the range) recovery in a default scenario.

"The outlook revision reflects our expectation that industry conditions will remain weak through 2016, reflecting depressed crude oil and natural gas prices and resulting in reduced capital expenditures from exploration and production companies," said Standard & Poor's credit analyst Aniki Saha-Yannopoulos. In addition, as rigs roll off contracts, Precision will either recontract or operate them at much less favorable day rates. "However, we expect credit measures to improve in 2017 due to our assumption of improving cash flow and credit measures as commodity prices improve in our base-case assumptions," Ms. Saha-Yannopoulos added.

The company's "satisfactory" business risk profile reflects our view of Precision's high-quality land drilling rig fleet, dominant market position in Canada and presence in several unconventional producing regions in the U.S., and ability to maintain less volatile EBITDA margins throughout the hydrocarbon price cycle compared with that of peers. We believe these factors, in conjunction with the company's long-term contracts, are the primary factors supporting the overall business risk profile. Given the industry's increasing emphasis on developing unconventional oil and gas resources and drilling horizontal wells, we expect Precision will maintain its Tier 1 fleet utilization and dayrates higher than industry average, especially in Canada. At the same time, as exploration and production companies focus on improving efficiency from their vendors, we expect drillers with higher-specification assets are at an advantage and will experience better utilization and margins compared with those of peers. In both Canada and the U.S., the company is one of the top providers of Tier 1 rigs, holding about 50% of the market and meaningful market share in multiple U.S. basins. Precision's diverse customer base supports its scale, scope, and diversity. We also view as a credit positive the company's rigs on long-term contracts, as well as the recent two new-builds for Kuwait, which are a source of stable cash flow. We forecast that long-term contracts will generate 45%-55% and 20%-30% of EBITDA in 2016 and 2017, respectively.

Our analysis of Precision's "significant" financial risk profile incorporates our view of the company's forecast core and supplemental ratios during our 2015-2017 outlook period. We are forecasting a drop in revenues and EBITDA through 2016 as industry activity drops and Precisions rigs roll off contracts. At the same time, the credit measures also reflect the upfront capital expenditures associated with the two new-builds for Kuwait, which should start operations and generate cash flow in 2017. We are also assuming that, beyond 2016, the company will limit spending to close to maintenance levels while utilization and margins recover. As a result, the forecast cash flow protection metrics, specifically fully adjusted debt-to-EBITDA and funds from operations (FFO)-to-debt, are somewhat weaker through 2016 but start improving in 2017 and beyond.

The negative outlook reflects Standard & Poor's view that Precision's credit measures will continue to weaken significantly through 2016 such that FFO-to-debt will drop below 20% before we expect any improvement in the company's 2017 cash flow and credit metrics.

If we expect operating cash flow pressure beyond our expectations in the next two years such that our estimated three-year average FFO-to-debt (2016-2018) were to decrease below 25%, we could lower the rating to 'BB-'. Under our base-case scenario, if 2017 and later revenue growth is less than 10%, due to sustained deterioration in utilization and dayrates well below our forecast levels, credit measures would weaken below 25%. In addition, Precision could breach the 25% threshold if it were to increase debt leverage to construct new contracted rigs; however, we would need to assess the benefit from the contracted revenues versus the uptick in debt leverage.

We would revise the outlook to stable if we were to expect Precision's outer year FFO-to-debt to improve significantly such that the company's three-year (2016-2018), weighted FFO-to-debt improves above 30%, mostly driven by the better 2017 and 2018 credit measures. We expect this due to increased drilling activity following higher commodity prices.

You May Also Be Interested In

• Netflix's subscribers, TSMC, Tesla upside - what's moving markets
• US signals Venezuela oil sanctions relief at risk as deadline looms
• Netflix subscribers, oil prices, Bitcoin volatility - what's moving markets