Oil Services Company Petrofac Downgraded To 'BB+' On Poor Backlog Visibility; Outlook Negative

  • Historically low crude oil prices are likely to result in lower capital expenditure (capex) across the oil & gas (O&G) industry, with more projects being delayed or cancelled.
  • Engineering and construction company Petrofac enters the downturn with a less-than-supportive backlog, which weakened further after the recent cancellation of a $1.5 billion project.
  • We are therefore lowering to 'BB+/B' from 'BBB-/A-3' our long- and short-term issue credit ratings on Petrofac.
  • The negative outlook reflects the potential downside to the company's profitability and backlog if forecast spending in the global O&G industry is further trimmed.
LONDON (S&P Global Ratings) April 28, 2020--S&P Global Ratings today took the rating actions listed above.
We are lowering our ratings on Petrofac to 'BB+' from 'BBB-' on the back of very difficult market conditions, with oil prices at historically low levels, and uncertainty regarding the company's ability to replenish its order book, after a weak order intake over the past 12 months. We now project EBITDA of about $400 million with very limited upside, if any, in 2021. The company's ability to secure $4 billion or more in new orders before the year-end would be an important milestone to mitigate additional pressure on the rating.
The cancellation of the $1.5 billion Dalma project, combined with broader weakness across the O&G sector, have constrained Petrofac's backlog.  After a weak order intake in 2019 of only $3.2 billion, the company finished the year with a backlog of $7.4 billion; it expected to recover its position in 2020. Although it achieved positive momentum earlier in the year, securing two contracts worth a combined $1.5 billion under ADNOC's Dalma Gas Development Project, this proved short-lived. On April 16, ADNOC announced the cancellation of the Dalma contracts, which had only been awarded in February. Petrofac now has only $0.5 billion of new orders booked since Jan. 1. We understand that the cancellation is linked to the weak oil prices, rather than any other reasons. As a result, we see a risk that other O&G projects could also see delays or cancellations.
Given a backlog worth $4.5 billion on execution in 2020, Petrofac would need to secure contracts worth about $3.0 billion to maintain a backlog of about $6 billion. We consider this level key to our assessment of its business risk profile as fair. In the year-to-date, the company has secured contracts worth only $0.5 billion.
Petrofac's balance sheet and lack of debt anchor our rating on it.  The modest financial risk profile is supported by the company's commitment to run its operations without leverage and its flexible dividend policy. Ultimately, the financial risk profile is underpinned by Petrofac's ability to maintain S&P Global Ratings-adjusted funds from operations (FFO) to debt of 60% or more while the U.K. Serious Fraud Office (SFO) investigation is ongoing, or 45%-60% during the low points of the cycle, taking swings in working capital into account. In our view, the ability to generate positive free operating cash flow (FOCF), even during weak periods, will allow the company to defend its financial objectives.
The key elements supporting the current assessment, and maintaining an adjusted FFO to debt about 60%, include:
  • Its low debt level--on Dec. 31, 2019, Petrofac reported a net cash position of around $15 million.
  • The cancellation of the recently announced $85 million dividend.
  • Positive FOCF of $250 million-$300 million in the 18-24 months to December 2021. During this period, the company expects to see the material working capital outflow in 2020 being reversed in 2021.
The SFO investigation continues to cast a shadow.  The investigation into Petrofac's activities started in May 2017 and is still ongoing. In 2019, it expanded into additional regions. No charges have yet been brought against Petrofac.
Should a fine be imposed, we estimate that the company could absorb a one-off payment of several hundred million dollars without affecting its liquidity and rating, all else being equal. Our main concern remains the potential impact on the company's ability to tender projects if charges are indeed brought. The reputational effect could weigh on the rating.
The negative outlook primarily captures the low visibility regarding the global O&G industry pipeline. We see a risk that lower awards could trigger a further decline in Petrofac's backlog and profitability in the coming years. In our view, this risk could materialize if crude oil continued to trade at or below our assumption of $30/bbl in the rest of 2020 and below $50/bbl in 2021.
In addition, a deterioration in Petrofac's liquidity position could also be a trigger. This will make it harder for the company to deal with a hefty potential SFO penalty or any cost overruns.
In our base case, we forecast a softer adjusted EBITDA of about $400 million in 2020. This translates into positive FOCF (before working capital) of about $100 million-$125 million in 2020, or negative $150 million-$200 million after factoring in working capital outflows. Looking into 2021, we expect an improvement, as EBITDA increases and working capital flows are reversed.
We consider adjusted FFO to debt of more than 60% commensurate with the current 'BB+' rating as long as the SFO investigation continues. Although FFO to debt will be around 30%-35% in 2020, under our base case, we expect it to go back to above 60% starting 2021.
We would lower the rating if a combination of the following scenarios materializes:
  • Adjusted FFO to debt remaining below 60% after 2020, without a clear recovery path or after factoring in a single sizable one-off potential fine from the SFO.
  • A further decline in the company's backlog to $5.0 billion or below by year end.
  • Impairment in the company's liquidity position that would prevent it from absorbing a one-off fine from the SFO without the need to refinance its maturities. A key checkpoint would be the refinancing of its $1.2 billion revolving credit facility (RCF) in the coming months.
  • Any negative consequences from the SFO's criminal investigation (for example, substantial charges against Petrofac or the inability to compete for new awards).
We could revise the outlook to stable in the next six to 12 months if we saw a recovery in the O&G industry, and a material rebound in oil prices.
Other conditions that could support an outlook revision include:

  • Building a track record of securing new awards and restoring the backlog to $6 billion or more, while maintaining at least the same historical profitability levels.
  • Successfully refinancing the RCF and rebuilding some more headroom in the liquidity (particularly while the SFO investigation has not concluded).
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