24th May 2016 09:26
LONDON (Alliance News) - Ratings agency Moody's late Tuesday said it has changed its outlook on Petrofac Ltd to Negative, as the oilfield services provider is only just managing to maintain its current debt rating and is having to deal with an increasingly challenging market in the Middle East.
Petrofac has managed to maintain its Baa3 rating from Moody's, but the agency believes there is a good chance the company could lose that rating as it is "just at the threshold" required to maintain it, whilst the environment within Petrofac's main market in the Middle East is expected to worsen.
The outlook, therefore, was downgraded to Negative from Stable.
"The negative outlook reflects Moody's expectations that leverage over the next two years will be higher than previously expected, with Moody's adjusted gross leverage at approximately 3.0x in 2016, with limited deleveraging in 2017," said Douglas Crawford, vice president and senior credit officer.
"This is just at the threshold the rating agency required to maintain the Baa3 ratings and is with a backdrop of an increasingly challenging oil and gas environment in the Middle East, where Petrofac has 67% of its [order] backlog," Crawford added.
Analysts have previously seen the Middle East as one area of potential growth for oilfield service companies compared to the rest of the world.
Moody's believes Petrofac could reduce leverage by selling part of its Mexican assets or by reducing dividends, an idea that is unlikely to be welcomed by shareholders. Petrofac kept its dividend flat in 2015 but has not committed to, or provided any guidance on, a dividend for this year.
Petrofac has been operating in Mexico since 2011 and has operations employing around 350 people spread across Mexico City and Villahermosa. There are numerous major contracts that facilitate the company's operations in country, and clients include state-owned oil giant PEMEX.
Although Moody's believes a sale could help, it stressed that it would reduce scale for the company, which is already small compared to many of its investment-grade peers.
Petrofac experienced a mixed year in 2015 after incurring heavy losses on the Laggan-Tormore project in the UK North Sea, but also managing to increase its order backlog up to record levels.
The company's current USD20.70 billion order backlog is mainly made up of work found in the Middle East, driven by major new awards in Kuwait and Saudi Arabia, whilst future bidding activities are also growing in the region.
Yet Moody's seems concerned that Petrofac has too much work from the Middle East.
"Moody's now expects the challenging oil and gas environment impacting sovereigns in the area increases the uncertainty on the number of new contracts that Petrofac can win and increased competition will also add to potential margin pressure going forward," the ratings agency said.
"Specifically there have been a number of prospective projects cancelled in Abu Dhabi and delays in Saudi Arabia, which raises the risk of this being repeated in neighbouring countries," Moody's added. "However, although UAE and Saudi Arabia each represent 14% of Petrofac's backlog, there is no evidence that this has been affected yet."
On the positive side, Moody's believes Petrofac has very competitive costs for its core onshore engineering and construction business, which accounts for around two-thirds of its overall revenue, and is impressed by the size of its clients compared to its own size.
Petrofac currently has a market capitalisation of GBP2.76 billion.
Moody's also said Petrofac has a good track record minus Laggan-Tormore and thinks the company's strong position in the Middle East is beneficial despite headwinds in the region.
However, on the flip side, Moody's highlighted the ongoing cuts to capital expenditure by oil and gas companies, meaning there is less work and less money to be pursued by service companies. The agency also has concerns about the reliance on huge turnkey projects which carry more risks and higher potential to overrun on cost, with Laggan-Tormore being a prime example.
Moody's currently views Petrofac's liquidity as satisfactory although exposed to working capital swings. The company has USD1.10 billion in cash at the end of 2015 and USD660.0 million available under its revolving credit facility which matures in 2020. That should be sufficient to cover the USD500.0 million credit facility set to mature in August this year.
Moody's also expects Petrofac to be able to fund its capital expenditure this year of USD100.0 million to USD150.0 million and to make dividend payments totalling around USD200.0 million, but said this would likely result in negative cashflow being generated.
"The rating agency currently views covenant headroom as adequate but will be weakened at the end of the first half of 2016 following the final announced loss on the Laggan-Tormore contract in 2016," Moody's said.
Petrofac shares were trading flat on Tuesday morning at 795.0 pence.
By Joshua Warner; [email protected]; @JoshAlliance
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