Close

Moody's Lowers McDermott (MDR) CFR to 'Ba3'; Sees Operating Results Still Weak in 2014 Amid Improvement

April 2, 2014 2:31 PM EDT
Moody's Investors Service downgraded McDermott International's (NYSE: MDR) corporate family rating (CFR) to Ba3 from Ba2, affirmed its probability of default rating of Ba3-PD and maintained its Speculative Grade Liquidity Rating of SGL-3. The CFR downgrade reflects McDermott's significantly weaker than expected operating results which, combined with its spending on growth investments, has resulted in a substantial increase in outstanding borrowings and a significant deterioration in its credit metrics. The ratings outlook is negative.

Moody's assigned a Ba1 rating to McDermott's proposed first lien senior secured credit facility and a B1 rating to the proposed senior secured notes. The company plans to establish a $700 million first lien credit facility consisting of a $400 million letters of credit facility and a $300 million term loan and also plans to issue $500 million of second-lien senior secured notes. The proceeds from these fundraising initiatives along with the cash raised from the tangible equity units issued on April 1, 2014 will be used to pay off the outstanding balance on the company's revolving credit facility, fund working capital requirements and prefund capital expenditures planned over the next two years. The company plans to terminate its existing revolver when the proposed refinancing is complete. The Ba1 rating on McDermott's senior secured revolving credit facility will be withdrawn when the facility is terminated.

The following rating action was taken:

Corporate Family Rating lowered to Ba3;

The following rating was affirmed:

Probability of Default Rating Ba3-PD;

The following rating will be withdrawn when the facility is terminated:

$950 million senior secured credit facility Ba1 (LGD2, 16%)

The following ratings were assigned:

$700 million senior secured first lien credit facility Ba1 (LGD2, 23%);

$500 million senior secured notes B1 (LGD4, 61%)

Outlook is negative

RATINGS RATIONALE

McDermott's Ba3 corporate family rating reflects its good market position in a niche segment that has favorable long-term fundamentals supported by worldwide growth in oil and natural gas consumption. The company also has a sizeable order backlog, an enhanced focus on cost control, project risk management and project execution, and adequate liquidity, which provides a cushion against the downside risks inherent in its business. However, the offshore E&C industry is highly cyclical and competitive and McDermott works under very large, fixed-price contracts that are susceptible to execution issues and cost overruns and have relatively low margin for error due to competitive bidding primarily against larger and more diversified companies. As well, the company's business risks have been increasing as deeper water and subsea projects become a larger percentage of its backlog of work.

The nature of McDermott's business, which includes sizeable fixed priced offshore oil & gas projects, lends itself to volatility in orders, project timing, revenues and profitability and encompasses high execution risk. These risks have been evident in the company's recent project execution and operating results. The company entered 2013 with a sizeable order backlog of about $5.1 billion; however the backlog was concentrated with work scheduled to be completed in 2014 and beyond. Therefore, the company's 2013 order book was light and the company was unable to compensate with shorter book and bill work. This led to an underutilization of the company's resources and was compounded by project execution issues related to mechanical and technical problems with the company's vessel fleet, lower than expected productivity on a few projects and lower than anticipated settlements with customers on unapproved claims. The company also recorded asset impairment charges related to changes in its capital expenditure plans and goodwill impairment charges related to previous acquisitions. This resulted in McDermott producing negative adjusted EBITDA of $140 million in 2013 versus positive EBITDA of $491 million during the prior year.

Moody's expects McDermott's operating results to improve substantially in 2014, but to remain weak. The company should benefit from the timing of projects in its backlog, recent challenging projects approaching completion and the business improvement and cost cutting initiatives it is implementing. However, operating results are still expected to remain at a depressed level until the company commences the marine installation phase of the $2 billion Inpex Ichthys project, which is currently expected to occur in late 2014. Therefore, Moody's is expecting McDermott to produce 2014 adjusted EBITDA in a range of $100 million to $150 million with most of the EBITDA generation weighted to the back half of the year. The expected improvement in 2014 adjusted EBITDA will still result in very weak metrics for the company's rating since its operating performance will remain lackluster and the company is taking on substantial borrowings to prefund its investments in growth initiatives such as new vessels and new fabrication capacity. McDermott's adjusted leverage ratio (Debt/EBITDA) is expected to be about 12.0x and its interest coverage ratio (EBITA/Interest Expense) about -0.7x at the end of 2014.

McDermott is expected to maintain adequate liquidity, as reflected in the SGL-3 rating, despite the expectation for weak operating results and elevated capital spending. The company is expected to have about $1.0 billion of cash and investments when the proposed refinancing is complete. However, we expect liquidity to decline materially in 2014 and 2015 unless operating results improve more significantly than expected, capital spending is reduced or the company pursues additional financing options.

McDermott plans to establish a $700 million first lien credit facility consisting of a $400 million letters of credit facility with a 3-year maturity and a $300 million term loan due in 5 years. Moody's assigned a Ba1 rating to the $700 million first lien credit facility since it will benefit from a first priority interest in all of the assets of McDermott International. Moody's assigned a B1 rating to the $500 million of senior secured notes, which is three notches below the below the $300 million first lien term loan due to its priority status.

The negative outlook reflects McDermott's recent execution issues and inability to curtail its operating losses. It also reflects the uncertainties regarding the ability of the new management team to significantly improve project execution and successfully implement business improvement initiatives that would return the company to operating profitability. The outlook could be stabilized to the extent the company demonstrates that it can achieve significantly improved operating trends and stronger credit metrics including EBITA-to-Interest Expense of greater than 2.0x and funds from operations of at least 20% of adjusted debt.

Given the recent poor operating results and elevated spending plans, upside rating movement in the medium term is unlikely. However, should McDermott be able to achieve substantially improved credit metrics including EBITA-to-Interest above 3.0x, Debt/EBITDA below 4.0x and funds from operations greater than 25% of outstanding debt, then a change in rating could be considered.

A downgrade could be considered if McDermott is not be able to achieve materially improved operating results, its credit metrics fail to improve or its liquidity position deteriorates materially. Downside triggers would include the leverage ratio not progressing towards 6.0x, the interest coverage ratio remaining below 2.0x and funds from operations below 15% of adjusted debt.

The principal methodology used in this rating was the Global Construction Methodology published in November 2010. Other methodologies used include Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA published in June 2009. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.


Serious News for Serious Traders! Try StreetInsider.com Premium Free!

You May Also Be Interested In





Related Categories

Credit Ratings

Related Entities

Moody's Investors Service