Emeco has updated the market on its performance in 3Q15.
At face value, the announcement paints a positive picture but provides limited details on the company’s third quarter financial performance.
Our view is that, while positive signs are emerging for the business, FY15 EBITDA may fall short of previous guidance. Without a strong fourth quarter performance, we continue to see further challenges on the credit outlook for Emeco as a standalone business.
Having said this, we also note the potential for a merger with Orionstone, which we consider would be credit positive for bondholders if it were to occur.
A summary of the announcement is outlined below:
- Revenue for 3Q15 was $67m, up 6% on 3Q14 and up 8% on the previous quarter
- The company indicated that EBITDA margins continued to increase quarter on quarter, however the EBITDA margins in the first two quarters of FY15 (9.3% and 18.8%) were exceptionally poor so it is difficult to determine actual EBITDA performance and whether it was positive or not. Based on an improved EBITDA margin of 20%-30%, we estimate Emeco may have earned between $13.4m and $20.1m EBITDA in the third quarter
- Group utilisation averaged 75% in Q315, up from 53% in Q314. However, we note that utilisation levels have increased partially as a result of a reduced fleet size
- The Canadian rental business experienced a strong winter season with average utilisation of 83%, which has declined to 68% as expected post-winter season. The company was able to place 40 pieces of equipment with a large coal company in Canada, which will go some way to smoothing out the cyclicality of the Canadian oil sands business
- The Chilean business continues to be negatively impacted by ramp-up and resourcing issues at the core Encuentro project
- In Australia, Emeco has seen strong utilisation in NSW, two new contract wins in Queensland will see utilisation increase from 59% to 82%, while performance in Western Australia is moderate and the company may look to move this fleet to support active contract bids in the eastern states
- The company has announced it will reduce costs into FY16, with an initial target of $10 per annum which is meaningful given the company’s weak earnings base
Based on our estimates of EBITDA above, Emeco may have earned somewhere between $30m to $36m of EBITDA for the three quarters to date of FY15. If this were to be the case, there is a high risk that FY15 EBITDA falls short of previous expectations of between $50 and $60m in the absence of a strong fourth quarter. There are signs though of improved performance, particularly in Queensland where the company has won two new contracts, however to what extent of improvement this will generate in fourth quarter EBITDA is unclear.
We note that Emeco earned $8.3m of EBITDA in 4Q14, and if Emeco were to achieve a similar result for 4Q15 the company may end up delivering $38m to $46m of EBITDA for the full year which would be a weak result for the company on a standalone basis, but please note these are high level estimates only. Based on an exchange rate of 0.80, Emeco’s annual interest bill on its senior secured 2019 bonds would $41m. Emeco does have cross currency interest rate swaps in place which would have provided some offsetting protection against the depreciating AUD.
The Emeco bonds do not have any maintenance covenants linked to EBITDA interest coverage, while the $75m asset backed loan does have an interest coverage covenant of 1.25x if more than 50% of the facility is drawn. While it is unclear how much of the asset backed loan has been drawn to date (it was undrawn at 31 December 2014), we expect it would be unlikely the company draws more than 50% of the asset backed facility in the current weak earnings environment.
For existing Emeco bondholders, the following considerations are of relevance:
- Emeco is rated B/B3 with a negative outlook. A weak FY15 result could see the Emeco credit rating fall into the ‘B-/Caa1’ category on the basis of a continuing downward trend in EBITDA performance. Based on historical S&P default statistics, a ‘B’ rated credit has a 18.51% probability of default over four years, while a ‘B-‘ credit has a 24.12% probability of default over the same period
- While the EBITDA interest coverage levels are likely to be very weak for FY15, we expect that the company has sufficient liquidity through available cash balances ($34.1m as at 1H15) and undrawn facilities to cover interest and meet ongoing operational costs over the short term. However, the medium to longer term credit and liquidity position of Emeco relies on an improvement in credit metrics, either through improved standalone performance or a credit positive transaction such as the Orionstone merger
- In the absence of an improvement in credit metrics prior to the bond maturity in 2019, refinancing of the USD335m senior secured bonds in full would be challenging without additional equity capital being raised. We note that S&P’s recovery rating on the Emeco senior secured bonds is at '3', reflecting the expectation of "meaningful" recovery prospects (50%-70% of bond principal) in the event of default
- With the potential for FY15 EBITDA/interest coverage levels to edge closer to 1.00x-1.25x levels if fourth quarter results disappoint, investors may consider that now is an opportunity to de-risk their position in Emeco. One possibility is to switch from Emeco into Ausdrill, which offers a high yield, is a comparatively stronger credit than Emeco and has experienced a solid run in recent times with two large contract wins
- As we’ve noted previously, we consider that a merger with Orionstone would improve the credit position of Emeco, albeit from a very low base. The company’s announcement yesterday indicated it has entered discussions with Orionstone to assess the benefits of a merger which is a positive step forward but there is no timeline on when these discussions will finish and when a merger would go ahead if at all. Bondholders may want to hold off on trading Emeco until an outcome on the proposed transaction is resolved
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