CHICAGO–(BUSINESS WIRE)–Fitch Ratings has downgraded Transocean Inc. (Transocean; NYSE: RIG) and its affiliate’s Long-term Issuer Default Rating to ‘BB’ from ‘BB+’. The Rating Outlook has been revised to Negative from Stable.
The downgrade reflects heightened offshore rig re-contracting risk and Fitch’s lower and longer offshore rig recovery profile following the downward revision of our oil & gas price assumptions. Fitch expects E&P companies to continue to reduce capital budgets to conserve liquidity and preserve balance sheets. This has and is likely to continue to broadly curtail offshore exploration activities and earlier stage developments resulting in fewer tenders and more short-term contracts for the next couple of years. These risks have resulted in a moderate increase in Fitch’s forecasted base case leverage profile over the near-term, but, more importantly, increased the uncertainty around forecasted non-current backlog revenues. Current contract coverage within Fitch’s base case decreases from roughly 90% in 2016 to under 70% in 2017 with further declines thereafter.
The Negative Outlook considers the potential for a deeper and longer than forecast offshore drilling downcycle that could result in Transocean’s leverage profile remaining above Fitch’s through-the-cycle levels for a ‘BB’ credit over the rating horizon. Fitch has pushed back its recovery inflection point estimate into the second half of 2018 from late 2017/early 2018.
Fitch’s inflection point estimate remains at risk for further delays due to the evolving hydrocarbon pricing environment, rig oversupply cycle, and offshore E&P spending trends. E&Ps will likely need to be highly confident that supportive prices are sustainable before meaningfully committing capital to new offshore projects given their higher development costs and multi-year development periods. Fitch believes that an uptick in demand could lag supportive oil & gas price levels (estimated at $65 – $70/barrel for deepwater) by at least six-12 months.
Fitch continues to recognize that Transocean has undertaken numerous actions to protect credit quality to-date including the early retirement of debt, eliminating the dividend, deferring uncontracted newbuild deliveries, proactively rationalizing undifferentiated/uneconomic legacy rigs (22 scrapped floaters announced; about 50% of industry total), reducing operating costs, increasing rig uptime, and mitigating Macondo-related credit risks. Fitch expects the company to exhibit a positive free cash flow (FCF) profile, retire a considerable amount of debt, and maintain adequate liquidity over the next couple of years. This should help better align the company’s capital structure with its evolving asset profile. Fitch also views Transocean as an eventual consolidator and management as capable through-the-cycle value creators that will enhance the company’s long-term competitive position and credit prospects.
Approximately $8.5 billion of debt, excluding the outstanding Eksportfinans loans, is affected by today’s rating action. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
Transocean’s ratings are supported by its market position as one of the largest global offshore drillers, strong backlog ($16.8 billion as of Dec. 6, 2015), favorable floater-focused rig fleet, high-grading and margin improvement efforts, and adequate near-term financial flexibility, including that afforded by uncontracted newbuild delivery delays. These considerations are offset by the company’s continued need to generate and conserve liquidity given current unfavorable capital market conditions, heightened maturities profile, and considerable newbuild capex commitments. Fitch believes the company’s current and near-term leverage profile (Fitch calculated 2.6x latest 12 months [LTM] debt/EBITDA as of Sept 30, 2015; Fitch base case forecasts consolidated debt/EBITDA of 2.7x in 2015 and 3.3x in 2016) are consistent with a higher rating. However, Fitch forecasts leverage metrics could exceed through-the-cycle levels over the rating horizon as current contract coverage meaningfully declines in 2017 with re-contracting risk elevated in this very weak market environment.
OIL PRICE WEAKNESS, RIG OVERSUPPLY CYCLE CONTRIBUTE TO DELAYED RECOVERY PROSPECTS
Offshore drillers continue to face depressed market conditions due to lower demand and a significant oversupply of rigs, including newbuilds. The roughly 70% drop in oil prices has compounded the effects of the offshore rig oversupply cycle resulting in continued market dayrate weakness. Fitch’s base case assumes market dayrates for high-specification ultra-deepwater rigs of $275,000/day. This is a downward revision from our previous base case estimate of $300,000/day due to the increasingly competitive contracting environment. Other rig classes are projected to see similarly steep price discounts. Fitch also recognizes that market dayrates could reach cash breakeven levels (about $200,000/day for high-specification ultra-deepwater rigs), but continues to expect operators will be cautious, particularly larger, established drillers, about bidding at or below cash breakeven levels. Fitch’s view remains that while customers may, in most cases, prefer the lowest cost, highest quality assets careful consideration will be given to an operator’s size, staying power, geological familiarity, and historical operating performance.
Fitch anticipates that the floating rig rationalization process will generally be more orderly than the jackup market and that it will rebalance more quickly. Fitch believes that the more competitive jackup market environment provides fewer economic incentives for operators to rationalize over the near-term. Offshore rig demand could lag a recovery to supportive oil price levels (currently estimated at $65 – $70/barrel for deepwater) by at least six-12 months to encourage operators to allocate additional capital to offshore projects. Fitch has pushed back its recovery inflection point estimate into the second half of 2018 from late 2017/early 2018 with a risk for further inflection point revisions. A recovery to more robust operating and financial metrics is not likely to happen until after that point.
POSITIVE FCF PROFILE FORECAST NEAR TERM, BUT LEVERAGE METRICS PRESSURED MEDIUM TERM
Fitch’s base case forecasts Transocean, excluding cash flows to non-controlling interests, will be approximately $825 million and $450 million FCF positive in 2015 and 2016, respectively. Fitch assumes that all surplus FCF will be allocated towards debt reduction over the next few years. Fitch’s base case results in consolidated debt/EBITDA, excluding cash collateralized Eksportfinans loans, of 2.7x and 3.3x in 2015 and 2016, respectively.
Leverage metrics, however, are anticipated to move higher and could exceed through-the-cycle levels thereafter. The Fitch base case currently forecasts consolidated debt/EBITDA of approximately 4.5x in 2017 followed by gradual leverage metric improvements. Given the current market environment, Fitch has placed increasing weight on its stress case scenarios that currently forecast that consolidated debt/EBITDA could reach and exceed 5x in 2017. Fitch believes, however, that prices and offshore demand are likely to recover in the out years as large capex cuts made across the industry to date begin to result in meaningful supply reductions.
Fitch’s key assumptions within our rating cases for Transocean include:
Fitch Base Case:
–Brent oil price that trends up from $45/barrel in 2016 to a longer-term price of $65/barrel;
–Current contracted backlog is forecast to remain intact with no renegotiations contemplated;
–Market dayrates are assumed to be $275,000 for higher-specification ultra-deepwater rigs with other rig classes seeing similarly steep price discounts through 2017 followed by some modest dayrate improvements thereafter;
–Fleet composition considers announced rig retirements and attempts to adjust for uncompetitive rigs due to their technological obsolescence, undifferentiated market position, or cost prohibitive through-the-cycle economics;
–Capital expenditures consistent with company guidance of $2 billion in 2015 with spending levels thereafter largely based on the current newbuild delivery schedule;
–No dividend payments forecast following its recently approved cancellation beginning in the fourth quarter of 2015;
–No Transocean Partners LLC (NYSE: RIGP) dropdowns or other related funding activity.
Fitch Stress Case makes the following key adjustments to the Fitch Base Case:
–Brent oil price that trends up from $35/barrel in 2016 to a longer-term price of $45/barrel;
–Market dayrates are assumed to be $200,000 for higher specification ultra-deepwater rigs with other rig classes seeing similarly steep price discounts;
–Capital expenditures assume some further newbuild deferrals in the out years.
Positive: No positive rating actions are currently contemplated over the near-term given the weak offshore oilfield services outlook. However, future developments that may, individually or collectively, lead to a positive rating action include:
For an upgrade to ‘BB+’:
–Demonstrated commitment by management to lower gross debt levels;
–Mid-cycle debt/EBITDA of approximately 3.5x on a sustained basis;
–Further progress in implementing the company’s asset strategy to focus on the high-specification and ultra-deepwater markets.
To resolve the Negative Outlook at ‘BB’:
–Demonstrated ability to secure tenders that constructively contribute to the backlog and cash flows signalling the company’s ability to manage the industry’s re-contracting risk and bridge its financial profile through-the-cycle;
–Illustrated progress towards management’s liquidity target of $4-$5 billion, while repaying scheduled maturities by year-end 2017;
–Mid-cycle debt/EBITDA of around 4.0x on a sustained basis.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
–Failure to generate positive FCF, repay near-term maturities, and retain adequate liquidity over the next couple years;
–Material, sustained declines in rig utilization and day rates signalling a heightened level of re-contracting and recovery risk;
–Mid-cycle debt/EBITDA above 4.5x – 5.0x on a sustained basis.
Fitch does not anticipate taking any further negative rating actions until visibility of the post-2016 cash flow, leverage, and liquidity profiles become clearer through a demonstrated ability to secure tenders, pay down debt, and manage financial flexibility over the next 12-24 months. Further material deteriorations to the company’s backlog and liquidity profile, as well as to the offshore contracting environment, could accelerate a negative rating action.
ADEQUATE NEAR-TERM LIQUIDITY POSITION
Transocean had approximately $2.2 billion of cash and equivalents as of Sept. 30, 2015. The company also had approximately $443 million in restricted cash investments associated with the required cash collateralization of the outstanding Eksportfinans loans and other contingent obligations. Supplemental liquidity is provided by the company’s $3 billion senior unsecured credit facility due June 2019, including a $1 billion sublimit for letters of credit. The company had $3 billion in available borrowing capacity as of Sept. 30, 2015 with the ability to request a $500 million upsizing of the facility, subject to the current, as well as any additional prospective, banks’ willingness to participate.
HEIGHTENED MATURITIES PROFILE
Transocean has annual senior notes maturities equal to $1 billion, $749 million, and $1.25 billion between 2016 and 2018. These represent the company’s 5.05% senior notes due December 2016, 2.5% senior notes due October 2017, 6% senior notes due March 2018, and 7.375% senior notes due April 2018. This excludes Eksportfinans principal amortization that is cash collateralized. Management has been actively repurchasing debt (approximately $292 million through Sept. 30, 2015) with cash in an effort to incrementally improve near-term liquidity (nearly 85% repurchased related to 2016-2018 maturities) by capturing a par discount (over 6%) and reducing interest payments. Fitch continues to forecast that the company can largely retire the scheduled near-term maturities with cash-on-hand and FCF.
Transocean, as defined in its bank credit agreement, is subject to a maximum debt to tangible capitalization ratio of 0.6 to 1.0 (0.4 as of Sept. 30, 2015), excluding intangible asset impairments and certain other items. Other customary covenants consist of lien limitations and transaction restrictions.
MANAGEABLE OTHER LIABILITIES
Transocean maintains several defined benefit pension plans, both funded and unfunded, in the U.S. and abroad. As of Dec. 31, 2014, the company’s funded status was negative $462 million. Fitch considers the level of pension obligations to be manageable and notes that the U.S. benefits freeze helps to alleviate any future pension-related credit risks. Other contingent obligations are principally comprised of purchase commitments totalling approximately $5.3 billion on a multi-year, undiscounted basis as of June 30, 2015.
Fitch downgrades the following:
–Long-term IDR to ‘BB’ from ‘BB+’;
–Senior unsecured notes/debentures to ‘BB’/RR4 from ‘BB+’/RR4;
–Senior unsecured bank facility to ‘BB’/RR4 from ‘BB+’/RR4’.
Global Santa Fe Inc.
–Long-term IDR to ‘BB’ from ‘BB+’;
–Senior unsecured notes to ‘BB’/RR4 from ‘BB+’/RR4.
The Rating Outlook has been revised to Negative from Stable.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 07 Dec 2015)
Dodd-Frank Rating Information Disclosure Form