S&P Boosts Rating on North American Energy Partners (NOA) to 'B'; Sees Firming Financial Risk Profile

Standard & Poor's Ratings Services said it raised its long-term corporate credit rating on Edmonton, Alta.-based North American Energy Partners Inc. (NYSE: NOA) to 'B' from 'B-'. The outlook is stable. At the same time, Standard & Poor's raised its issue-level rating on the company's senior unsecured debt to 'B' from 'B-'. The recovery rating is unchanged at '4'.

"The upgrade reflects our belief that NAEP should be able to sustain the financial risk profile improvements it realized in 2013, by limiting its capital spending to maintenance levels and maintaining stable balance-sheet debt," said Standard & Poor's credit analyst Michelle Dathorne. "Our base-case scenario also assumes the company will exploit underused assets to generate incremental revenue and cash flow growth without the need for additional capital spending," Ms Dathorne added.

Our forecasting assumptions also incorporate our view that the company should be able to sustain the stronger margins it generated in 2013 throughout our forecast period, and thereby generate the operating cash flow and margins necessary to support the 'B' rating.

The ratings on NAEP reflect Standard & Poor's view of the company's limited operational diversification, and diminishing visibility to future revenue growth, due to increasing competition from other service providers and in-sourcing among its principal customers. We believe NAEP's improved operating margins in its sole business segment, the heavy construction and mining division; its spending flexibility, which allows the company to reduce capital spending to maintenance levels without compromising its operating efficiency; and adequate liquidity offset these weaknesses.

In our opinion, NAEP's "vulnerable" business risk profile reflects its narrow business diversification and diminishing visibility to future revenue growth, and the improved profitability metrics it has been able to generate with its renegotiated service contracts with its key customers. Although we believe the company has a meaningful market position in overburden removal and other services to established oil sands producers in the Athabasca oil sands region in western Canada, and is able to secure additional service contracts outside the oil and gas industry, NAEP's margins and profitability have been vulnerable to unscheduled production outages, project delays, or cancellations.

In our view, the company's "aggressive" financial risk profile reflects its improved cash flow adequacy and leverage ratios following its rapid debt reduction in 2013 and the beginning of 2014, and stronger cash flow generation. Based on our assumption that NAEP will maintain its capital spending at maintenance levels throughout our 2014-2016 forecast periods, as the company should not have to incur significant incremental spending to generate the revenue growth we are forecasting, NAEP should be able to maintain its fully adjusted debt-to-EBITDA and funds from operations-to-debt at the levels we estimate.

The stable outlook reflects Standard & Poor's expectation that NAEP will be able to maintain the operating efficiency recently realized, and sustain stable EBITDA margins throughout Standard & Poor's 2014-2016 ratings forecast period. As we believe the company should be able to maintain its capital spending at maintenance levels, and still generate the revenue and EBITDA growth incorporated in our base-case scenario, its gross debt levels and cash flow adequacy metrics should remain commensurate with our expectations for the 'B' rating.

The company's materially improved financial risk profile is the most significant factor underpinning its 'B' credit rating. Moreover, our assessment of its cash flow adequacy and leverage profile is greatly enhanced by our projected FOCF and stable debt for NAEP throughout our 2014-2016 forecast period. If the company's spending accelerates such that it generates negligible or negative FOCF, this would have a material adverse effect on our assessment of NAEP's overall financial risk profile. If this occurs, we would lower the rating to 'B-'.

As additional debt reduction would not be sufficient to further enhance the company's credit profile and rating, a positive rating action would be contingent on a material improvement in NAEP's business risk profile. Given the substantial customer concentration risk that persists, and lack of operational diversification, we do not believe NAEP's existing business could strengthen sufficiently to bolster its overall credit profile. As a result, an upgrade to 'B+' is highly unlikely during our current outlook period.

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