CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed QGOG Constellation S.A.'s foreign and local currency Issuer Default Ratings (IDRs) and USD700 million senior unsecured notes due 2019 at 'BB-'. The Rating Outlook has been revised to Positive from Stable.
The Positive Outlook reflects the expectation of partial elimination of structural subordination as some operating company (OpCo) debt is paid in full over the next two years coupled with continuing deleveraging. During 2014, Olinda Star became the first of the company's operating assets to pay its debt in full, which improved cash flows to the holding company. Over the next two years, at least two additional assets may fully repay their OpCo level debt, further improving cash flows to the holding company and eliminating structural subordination.
Key Rating Drivers
Declining Leverage
The company has shown consistent ability to deleverage as the debt at the OpCos rapidly amortizes and EBITDA increases to expected levels. As of the last 12 months (LTM) ended June 30, 2014, leverage as measured by total debt to EBITDA was 4.6x, under Fitch's metrics, compared to 6.0x one year earlier. Fitch expects the company to lower its consolidated leverage ratio to below 4.0x by the end of 2015. Total debt as of June 30, 2014 reached approximately USD2.8 billion, while EBITDA was USD610 million. As of June 30, 2014, debt at the OpCo level amounted to USD2 billion.
Adequate Liquidity
Constellation's liquidity is supported by a 12 months' debt service reserve account and the company's cash on hand, which mitigates possible disruptions of cash flow to the holding company (HoldCo) from the OpCos due to debt restrictions at the OpCos. As of June 30, 2014, cash and cash equivalent, short-term investments and restricted cash amounted to USD416 million, of which approximately USD217 million were at the HoldCo level and the balance was at the OpCos. The company also established a three-year USD150 million committed line of credit with Banco Bradesco (Fitch IDR of 'BBB+') to cover working capital needs. This line was undrawn as of June 30, 2014.
Structural Subordination
The potential retention of cash flows after debt service at the OpCo level makes cash flow to the HoldCo less stable and less predictable than the cash flow from operations of the subsidiaries. Some of the project finance debt at the OpCos has cash sweep provisions and minimum debt service coverage ratios (DSCR) (e.g. 1.2 or above) restricting cash flow distributions to the HoldCo. Cash distributions to Constellation are sensitive to the operating performance of the OpCos' (i.e. the rigs') uptime performance. For example, in the case of the Alaskan-Atlantic operating assets, a decline in the uptime rate to 95% or below from the combined 15-year historical average of 96.3% will likely prevent these assets from distributing cash to the HoldCo. Gold and Lone Star financing are not expected to distribute any cash to the HoldCo until Gold Star is released from the associated financing and Lone Star until all debt is paid off, which is expected to fully amortize by 2017. Under Fitch's base case assumption of an average uptime rate of 94%, net cash flow distributions to Constellation from its OpCos is expected to average between USD130 million and USD200 million over the next three years. Net distributions to Constellation are expected to notably increase beyond 2017 as some project finance debt is fully amortized and could be higher if uptime rates are higher than projected.
Predictable Revenues
Constellation's consolidated revenues and cash flow from operations are stable and predictable, reflective of its long-term contractual structure, for the most part with Petrobras. After the delivery of Brava Star, an Ultra Deep Water (UDW) drillship, expected in January 2015, the company will operate a total of nine offshore drilling units under long-term contracts with Petrobras. The average remaining contract life for its existing majority-owned offshore drilling assets is approximately three years. The company also operates nine onshore rigs, which are also, for the most part, contracted with Petrobras. The bulk of the HoldCo's cash flow comes from its offshore services.
Strong Backlog
Constellation's current contract backlog, excluding contract renewal options, of approximately USD10 billion bodes well for the company's credit profile as it supports cash flow predictability. Of the company's current backlog, approximately half relates to the offshore drilling assets where the company has majority participation. The balance of the backlog relates to other assets without majority participation as well as its onshore assets.
Strong Demand for Drilling Rigs in Brazil
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 USD220 billion over the next four years. Further, the government has implemented a 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.
Rating Sensitivities
Considerations that could lead to a negative rating action (rating or Outlook) include:
--Failure to lower leverage to 4.0x or below;
--An overly aggressive growth strategy that could pressure credit metrics (somewhat mitigated by the issuance's covenants).
Considerations that could lead to a positive rating action include:
QGOG Constellation's ratings could be upgraded as the company significantly eliminates structural subordination and lowers its leverage more in line with the assigned ratings. This could naturally occur as OpCos amortize their original project finance debt and do not issue additional senior secured debt at the OpCo level. QGOG's credit quality would also benefit as the company renews its contracts with long-term agreements with creditworthy offtakers at fixed day rates.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 2014);
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=900154
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