Standard & Poor's Ratings Services (S&P) has cut the corporate credit rating of Fort Worth, TX-based FTS International Services LLC, one of the top five hydraulic fracturing (fracking) service providers in North America, because it said capacity additions and rising costs, combined with moderating demand and low natural gas prices, are pressuring margins in the fracture stimulation industry.
The outlook for the company, formerly known as Frac Tech Services LLC, was reduced to "negative" and ratings were cut to "B" from "B+." The ratings reduction on Thursday came the same day that PacWest Consulting Partners issued an analysis indicating that aggregate U.S. pressure pumping supply exceeded demand late last year and in 1Q2012 (see Shale Daily, June 1).
"As a pure-play fracturing services provider, FTS has already experienced lower margins over the past two quarters, and we have reduced our margin and [earnings] estimates for the remainder of 2012 and 2013," said S&P credit analyst Carin Dehne-Kiley. "As a result, we expect credit protection measures at the end of 2013 to weaken beyond levels appropriate for the 'B+' rating category, and thus we are lowering the corporate credit rating."
The rating reflects FTS' "weak" business risk, "highly leveraged" financial risk, and "less than adequate" liquidity. Fracking services "are subject to a high degree of demand and price volatility. Although FTS focuses on the fracking services product line, it also assembles fracking units, manufactures components, produces fracking chemicals and proppants (sand), and provides proppant logistics services (transportation and storage).
"We believe this vertical integration provides a competitive advantage by assuring timely deliveries, reducing maintenance downtime and avoiding the proppant delivery bottlenecks that have plagued others in the industry. However, in a market downturn the excess manufacturing, processing, and transportation capacity could lower margins."
The negative outlook "reflects FTS' potential covenant violations," and S&P analysts expect that the debt-to-earnings ratio could exceed levels appropriate for its rating category. "We could revise the outlook to stable if the company is successful in resolving its potential covenant violations, and if U.S. market conditions improve above our current expectations and we believe these conditions will be sustainable. We could also revise the outlook to stable if the company is successful in meaningfully reducing its debt, potentially from an initial public offering or strategic investor."