CHICAGO, January 29 (Fitch) Fitch Ratings expects to rate Schahin Oil and Gas Ltd.’s (Schahin or Holdco) proposed USD685 million senior unsecured notes issuance ‘BB-'. Fitch has also assigned foreign and local currency Issuer Default ratings (IDRs) of ‘BB-’ to Schahin. The Rating Outlook is Stable. The company expects to use the proceeds from the issuance to refinance subordinated debt at some of its subsidiaries as well as debt at the holding company level.
Schahin’s ratings reflect the company’s high consolidated leverage and structural subordination to its operating subsidiaries’ project finance debt. Positively, consolidated leverage is expected to decline over time as the project finance debt at the operating companies amortizes. The OpCos assets have long-term contracts in place that allow them to better match project debt with the life of the assets, which results in low debt service requirements and greater cash flow distributions to the holding company. Upstream distributions from the four cash generating assets are not expected to be disrupted, nevertheless they are subject to various distribution tests.
Schahin’s ratings also reflect the stable and predictable cash flow generation of the company’s OpCos’ offshore drilling assets, which are supported by long-term contracts with investment grade rated Petroleo Brasileiro S.A. (Petrobras; IDR ‘BBB’). The ratings also incorporate the favorable demand prospects for oil and gas services in Brazil driven by Petrobras’s aggressive capital expenditure program as well as new exploration and production entrants to the market.
The company’s pro forma consolidated leverage is considered high for the rating category and is expected to decrease over time as the debt at the OpCos amortizes to levels more consistent with the rating category. Fitch expects pro-forma leverage as measured by total debt to EBITDA to range between 6.5x and 7.5x for 2013. Fitch expects the company to lower its consolidated leverage ratio to below 4.5x within the next three to five years, which is more in line with the assigned ratings. Total debt on a pro forma basis and considering the proposed issuance is expected to reach approximately USD3.6 billion by year-end 2013, while EBITDA for this year is expected to range between USD520 million and USD570 million. As of Sept. 30, 2012, debt at the OpCos level amounted to USD3.1 billion, out of approximately USD3.9 billion of total consolidated financial debt.
Schahin’s liquidity is supported by a twelve months debt service reserve account and dividend distributions from its subsidiaries. As of Sept. 30, 2012, the company’s unrestricted cash position was low with only USD1.4 million of cash and cash equivalent while consolidated short-term debt amounted to USD759 million (consolidated restricted deposits amounted to approximately USD150 million). During 2013, the company’s liquidity position is expected to improve as a result of dividend distributions from the OpCos. The company expects to use a portion of the proceeds from the proposed debt issuance to refinance USD356 million of short-term debt related to Vitoria subordinated debt.
Schahin’s consolidated revenues and cash flow from operations are stable and predictable, reflective of its long-term contractual structure with Petrobras. The company provides offshore oil and gas drilling services through its different subsidiaries. The average remaining contract life for its existing offshore drilling assets is approximately eight years. The company currently operates six offshore drilling units under long-term contracts with Petrobras. The bulk of the HoldCo’s expected cash flow will come from dividends from its 100% owned OpCos as well as from cash flow from operations from its leased asset, Victoria, and the potential minority investments in three new FPSOs. Schahin has a good operating track record in the drilling sector. During 2012, the uptime for the four assets that will distribute dividends to Holdco averaged 95.1%.
Schahin’s current contract backlog, excluding contract renewal options, of approximately USD6.8 billion bodes well for the company’s credit profile as it supports cash flow predictability. Of the company’s current backlog, USD5.4 billion relate to the existing offshore drilling assets, where the company has majority participation, all of which are contracted with Petrobras. The balance of the backlog relates to three FPSOs for which the company has acquired the option to purchase between 10% and 15% equity participation upon construction completion.
STRUCTURAL SUBORDINATION TO OPERATING COMPANIES’ DEBT
The potential retention of cash flows after debt service at the OpCos level makes cash flow to the Holdco somewhat less stable and predictable than the cash flow from operation of its subsidiaries. Most of the project finance debt at the OpCos have cash sweep provisions and minimum debt service coverage ratios (DSCR) (e.g. 1.2 or above) that must be met before cash flow distributions are allowed to be made to the Holdco. Specific assets (S.S. Panatanal and S.S. Amazonia) are not expected to distribute excess cash to the holding company until all project finance debt and subordinated debt is repaid.
Cash distributions to Schahin are sensitive to the operating performance of the OpCos’ (the rigs’) uptime performance. For example, in the case of the Cerrado and Sertao operating assets, a decline in the uptime rate to 86% and 85% for three and six months, respectively, will likely prevent these assets from distributing cash to the Holdco. Under Fitch’s base case assumption of an average uptime rate of 95%, these two assets are not expected to trap cash. Also, under Fitch’s base case assumptions, net cash flow distributions to Schahin from its OpCos, after considering planned investments and holding company operating expenses, is expected to range between approximately USD40 million and USD280 million and to average approximately USD125 million per year over the next five years. Total debt to net dividend distributions at Holdco is expected to average approximately 2.9x over the next five years. Net distributions to Schahin are expected to increase starting 2017 as some project finance debt is fully amortized and should increase if uptime rates are higher than projected.
Long-term demand prospects for oil and gas services in Brazil, including demand for offshore drilling rigs and production equipment, are strong. Driven by a government initiative to increase the country’s oil and gas production, Petrobras has embarked on an aggressive capital investment program of up to USD236 billion over the next four years. Further, the government has implemented requirement that a high percentage of the work and materials provided for these expenditures be from ‘local’ sources in order to boost economic activity. The combination of higher demand and the local content mandate for oil and gas related services support long-term demand prospects for the company as well as its ability to renew contracts at favorable rates.
Factors that could lead to a negative rating action are: Failure to lower leverage to 4.5x or below or an overly aggressive growth strategy that could pressure credit metrics.
Key considerations for a positive rating action or outlook would be a faster deleveraging process coupled with a reduction of the holding company’s structural subordination to its operating assets.