PRECISION DRILLING C

PD
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Fitch Affirms Precision Drilling's IDR at 'B+'; Outlook Stable

04/08/2022 | 03:10am

Fitch Ratings has affirmed Precision Drilling Corporation's (Precision) Long-Term Issuer Default Rating (IDR) at 'B+'. Fitch has also affirmed Precision's senior secured revolver at 'BB+'/'RR1' and the senior unsecured ratings at 'B+'/'RR4'.

The Rating Outlook is Stable.

Precision's rating reflects the company's execution on debt reduction initiatives, strong liquidity profile, and lack of near-term maturities. Fitch expects continued FCF generation with proceeds allocated towards debt repayment, which should help maintain credit metrics within rating tolerances.

Offsetting factors include uncertainty around increases in E&P development spending as public producers remain disciplined despite historically high prices. Other concerns include supply chain disruptions leading to increased service and labor costs that will have to be offset by continued increases in day rates.

Key Rating Drivers

Improving Rig Count, Higher Costs: Both U.S. and Canadian rig counts have seen slower, more gradual increases since bottoming out in 2Q20. Public producers continue to remain disciplined with development spending as they maintain production profiles and return FCF to shareholders. Day rates in the U.S. have moved into the USD25,000 range for active rigs, which has supported modest margin increases for Precision in 4Q21 and are also expected in 1Q22. Margin increases should be feasible in the near term as utilization rates improve, but sustainable increases in the medium term could be challenged by weakening rig demand and/or labor constraints. Fitch believes Precision will have to continue increasing day rates in the near and medium term to offset higher service and labor costs as supply chain disruptions pressure the industry.

Modest Capital Program; Positive FCF: Management has guided towards a capital budget of approximately CAD98 million in 2022, (CAD56 million of maintenance and CAD42 for upgrade and expansion spending) up from CAD76 in 2021, with a focus on FCF generation. Fitch's base case forecasts approximately CAD100-CAD140 million FCF in 2022 and 2023, assuming modest improvements in rig counts and margins from 4Q21.

Continued Debt Reduction; Strong Liquidity: Fitch expects Precision's liquidity profile will remain strong throughout the rating horizon and views management's CAD75 million debt reduction target in 2022 and CAD400 million debt reduction target over four years as achievable given the positive FCF forecast. Gross debt reduction totaled CAD115 million in 2021, and the company has repaid approximately CAD665 million of total debt since 2018. FCF is expected to be allocated to reduce revolver borrowings in 2022 as the company exited 2021 with US118 million outstanding (US33 million in outstanding letters of credit) under the USD500 million credit facility.

Improving Leverage; Clear Maturity Profile: Fitch's base case forecasts leverage at 3.3x in 2022 and improving thereafter through a combination of expected gross debt reduction and modest increases in pricing and activity levels. The maturity profile also remains muted with no significant maturities until the revolver matures in 2025. Fitch expects debt repayment will largely be aimed at the credit facility in the near term and believes management will look to return capital to shareholders via share buybacks.

Leading Canadian Share: Precision has a leading market share in Canada, with approximately 33% of active rigs in key Canadian basins. The company's current Canadian fleet consists of 109 drilling rigs and 188 well service rigs. Fitch anticipates drilling activity will modestly improve through 2022. Precision should continue to maintain market share given its success and growth in digital leadership through its Alpha Technology services, which are not exposed to pricing competition and help improve overall utilization rates.

Volatile U.S. Operations; Competitive Pricing: U.S. operations are historically more volatile than Canadian operations, although both regions are seeing a slower, extended recovery since pandemic lows in 2Q20. Fitch estimates Precision has the fourth-largest market share at approximately 9% market share, an improvement from approximately 6% in 2015. Fitch expects improving activity levels in the U.S. for 2022, similar to Canada, but believes supply chain disruptions and higher service and labor costs could limit margin expansion in the medium term.

Derivation Summary

Precision's primary peer is Nabors Industries (CCC+), which is also an onshore driller with exposure to U.S. and international markets. Fitch estimates that Nabors has the third largest market share in the U.S. at approximately 12% versus Precision at 9%. Nabors' gross margins in the U.S. are higher than Precision's and are helped by their offshore and Alaskan rig fleet, which operate at significantly higher margins. Precision has the highest market share in Canada at approximately 33%. However, Nabors has a significant international presence, which typically means longer-term contracts that partially negate the volatility of the U.S. market.

Precision has stronger leverage metrics and a much less significant maturity wall than Nabors. Nabors has more liquidity than Precision due to its larger revolver and higher availability, but Fitch expects both companies to generate free cash flow over their respective forecast periods and utilize the cash to reduce debt.

Compared to Enerflex, Ltd. (BB-/Stable), a global supplier of natural gas infrastructure and energy transition solutions, both companies have similar leverage profiles at around 3.0x and simple capital structures. Enerflex is larger, more diversified and cash flows are less susceptible to commodity price cycles through more stable, recurring revenue streams and long-term take-or-pay contracts with five to 10-year terms.

Key Assumptions

WTI oil price of USD95/bbl in 2022, USD76/bbl in 2023, USD57/bbl in 2024 and USD50/bbl thereafter;

Henry Hub natural gas price of USD4.25/mcf in 2022, USD3.25/mcf in 2023, USD2.75/mcf in 2024 and USD2.50/mcf thereafter;

Revenues increase by about 30% in 2022 due to improving rig count and day rates;

Capex of CAD98 million in 2022 given moderate increase in upgrade and expansion capital;

Free cash flow to remain positive with proceeds used to reduce debt.

KEY RECOVERY RATING ASSUMPTIONS

The recovery analysis assumes Precision would be reorganized as a going-concern (GC) in bankruptcy rather than liquidated. Fitch assumed a 10% administrative claim.

Going-Concern Approach

Precision's GC EBITDA estimate reflects Fitch's view of a sustainable, post-reorganization EBITDA on which the enterprise valuation (EV) is based. The GC EBITDA assumption for commodity sensitive issuers at a cyclical peak reflects the industry's move from top-of-the-cycle commodity prices to midcycle conditions and intensifying competitive dynamics.

The GC EBITDA assumption is relatively in-line with 2025 forecast EBITDA, which represents emergence from a prolonged commodity price decline. Fitch assumes a WTI oil price of USD67/bbl in 2022, USD42/bbl in 2023, USD32/bbl in 2024, USD42/bbl in 2025 and USD45/bbl over the long term.

The assumption also reflects loss of customers and lower margins, as E&P companies pressure oilfield service firms to reduce operating costs. It also reflects corrective measures taken in the reorganization to offset the adverse conditions that triggered default, such as cost cutting and optimal deployment of assets.

An EV multiple of 5.0x EBITDA is applied to GC EBITDA to calculate a post-reorganization EV. The choice of this multiple considered the following factors:

The historical bankruptcy case study exit multiples for peer energy companies have a wide range, with a median of 6.1x. The oilfield service subsector ranges from 2.2x-42.5x due to the more volatile nature of EBITDA swings in a downturn. The median is 7.4x.

Fitch uses a 5.0x multiple for Precision because of its high mix of Canadian rigs, weaker competitive position in the U.S. and relative mix of non-super spec rigs.

Liquidation Approach

The liquidation estimate reflects Fitch's view of the value of balance sheet assets that can be realized in sale or liquidation processes conducted during a bankruptcy or insolvency proceeding and distributed to creditors.

Fitch assigns a liquidation value to each rig based on management discussions, comparable market transaction values, and upgrade and new building cost estimates.

Different values were applied to top-of-the-line super spec rigs, lower value super spec rigs, non-super spec rigs and higher value international rigs.

The GC value was estimated at approximately CAD1.1 billion, or approximately CAD4 million per rig.

Fitch assumes the secured credit facility will be fully drawn upon default and is super senior in the waterfall. The value allocation in the liability waterfall results in a recovery corresponding to 'RR1' for the secured credit facility and a recovery corresponding to 'RR4' for the senior unsecured notes.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Increased size, scale and/or diversification;

Ability to maintain a competitive asset base in a credit-conscious manner;

Maintenance of liquidity and financial flexibility including low revolver utilization;

Midcycle gross debt/EBITDA below 3.5x on a sustained basis.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Failure to manage FCF that negatively affects liquidity and debt reduction capacity;

Deteriorating bank relationships that result in increasing covenant pressure or reduced liquidity;

Structural deterioration in rig fundamentals that results in weaker than expected financial flexibility;

M-idcycle gross debt/EBITDA above 4.5x on a sustained basis.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Strong Liquidity: Precision had CAD41 million of cash on hand as of Dec. 31, 2021, and USD118 million drawn (USD33 million of outstanding letters of credit) on its USD500 million revolver. There are no significant maturities due until the revolver matures in June 2025 and 7.125% notes mature in January 2026. Fitch anticipates the company will continue to be FCF positive over the forecast given the improving rig count and utilization rates which supports the liquidity profile.

Issuer Profile

Precision is an oilfield service company that owns and operates a fleet of 226 onshore drilling rigs that operate in Canada (109 rigs), the U.S. (104 rigs), and internationally (13 rigs), mainly in the Middle East.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

(C) 2022 Electronic News Publishing, source ENP Newswire

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