Overview -- U.S. oilfield services company Key Energy should continue to benefit from strong levels of oil-directed drilling. We expect Key's financial performance to remain strong for the rating. -- We are revising the outlook to positive from stable and affirmed the 'BB-' corporate credit rating. -- The positive outlook reflects the potential for an upgrade in 2013 if market conditions do not substantially decline from current levels.
Rating Action On Sept. 28, 2012, Standard & Poor's Ratings Services revised its outlook on Houston-based Key Energy Services Inc. to positive from stable and affirmed its 'BB-' corporate credit rating on the company.
Rationale The positive outlook reflects Key's improved financial and operating performance since 2008's industry-wide downturn. We expect near-term financial measures to remain strong for the rating in 2012 and 2013, with debt leverage of about 2.5x and funds from operations (FFO) to debt of about 30%. Although market conditions in the oilfield services industry have weakened in 2012 we believe industry conditions will remain supportive well through 2013, and will result in good credit metrics for the company. We forecast that it would take a greater than 45% fall from current EBITDA to approach our downgrade trigger of 3.75x debt leverage. Based on our current crude oil price assumptions of $80/bbl in 2013 and $75/bbl thereafter, we expect demand for oilfield services should remain adequate for the sector. It would likely take a precipitous downturn in crude prices, such as what occurred in 2008, when West Texas Intermediate (WTI) briefly fell to about $34/bbl, resulting in curtailment in capital spending by the exploration and production industry.
Finally, we expect the rapid growth in shale-oil wells to benefit Key's core workover rig division, used primarily to recondition and/or recomplete wells, supporting longer-term operational and financial performance. Eventual natural reserve production declines will increase demand for Key's services to arrest those declines and maintain production levels and well profitability.
The rating on Key Energy Services Inc. reflects our view of the company's "weak" business risk and "aggressive" financial risk profiles, as well as its "adequate" liquidity assessment. The company benefits from its diversification across the major U.S. oil and gas plays. This limits the negative effects to operational performance from a downturn in a specific basin or play, such as occurred in the Haynesville Shale. Key should also benefit from its growing international operations, which will add market diversity and buffer the more volatile North American market. Nevertheless, the well services industry remains volatile and exposed to the spending levels of the exploration and production industry. Repeated downward earnings guidance throughout the industry in 2012 points to this; however, we currently do not expect a significant decrease in demand for well services.
Key's financial results should remain solid. Based on our assumptions of revenue growth of 20% and gross margins of 31% in 2012, EBITDA should be about $390 million, total debt should be about $935 million, and FFO should be about $334 million. As a result, financial performance for 2012 should remain solid, with leverage of about 2.5x, FFO to debt of about 35%, and interest coverage of about 8x. 2013's estimated results reflect the weakening in market conditions during 2012. As a result, we have assumed no revenue growth and gross margins of 30%. These assumptions would yield EBITDA of about $370 million, FFO of about $310 million, and total debt of $1 billion. Financial measures remain adequate for ratings with debt leverage of between 2.5x to 3.0x, FFO to debt of about 30% and interest coverage of 6.5x.
We view Key's business risk profile as weak. Key is one of the largest and geographically diverse companies in the U.S. onshore well-services industry, with Nabors Industries Inc. and Basic Energy Services Inc. as its closest competitors. As a result, Key has been able to buffer the fall in natural gas drilling, particularly in the Haynesville Shale, by its positions in oilier markets such as California, Permian Basin and the Bakken and Eagle Ford Shales. About 80% of Key's revenues are tied to crude oil or NGLs. Nevertheless, despite continued demand for its service offerings, Key faces a very challenging and competitive market.
In addition to its exposure to unpredictable exploration and production-company spending, Key faces competition from smaller regional companies, particularly in pricing at times of low utilization. Nevertheless, thanks to its strong market position geographic diversity, including about 15% of revenues outside North America, we expect Key to maintain adequate operating performance to support expected financial measures.
In 2012, the U.S. oilfield services industry faced difficult circumstances, and we expect it to face further headwinds in the remainder of 2012 and into 2013. The rapid increase in both natural gas and oil drilling through 2011 led to high equipment orders throughout the oilfield services industry as operators tried to take advantage of very strong demand from E&P operators for completion and other services equipment. However, with the drop in natural gas drilling that began in 2011, there has been an oversupply of equipment in most markets compounded by a very competitive labor market.
As a result, Key's coiled tubing segment has underperformed expectations due both to delays in 2011 equipment deliveries and a shortage of labor in Key's markets at a time of softening margins. Likewise, market conditions have softened in Key's other segments, reflected in the recent announcement that revenues would decline 4% to 5% and operating margins 250 basis points to 350 basis points in the third quarter. Nevertheless, we currently expect that strong oil-directed drilling activity will act as a buffer to help support Key's operations. We expect that as many of the shale-based oil wells drilled over the past two years begin to see production declines, Key's core well servicing business, about 40% revenues, should benefit as companies recondition and/or recomplete wells to support production levels. As a result, we expect Key's operational and financial performance to remain adequate for the ratings, despite the near-term difficulties.
Liquidity We assess Key's sources of liquidity as "adequate." Key factors include: -- $650 million secured credit facility due March 2016 with $550 million commitments. -- Estimated availability on the credit facility of about $250 million to $260 million pro forma for its maximum debt to capital covenant of 45%. -- Sources of liquidity should exceed uses by 1.2x or greater. -- Based on our assumed capital spending of $375 million in 2012 and 2013, Key would outspend operating cash flows by about $160 million through 2013. -- Expectation that Key will remain in compliance with financial covenants.
Covenants include: -- Maximum debt leverage of 47.5% in Sept. 30, 2012, and 45% thereafter. -- Maximum secured debt leverage of 2.0x. -- Minimum interest coverage of 3x.
Finally, if market conditions were to substantially weaken from current levels, something we do not currently expect, we believe Key would reduce capital spending to preserve liquidity.
Recovery analysis For the complete recovery analysis, see Standard & Poor's recovery report on Key Energy Services, published on RatingsDirect on April 25, 2012.
Outlook The positive outlook reflects the potential for an upgrade in 2013 if market conditions do not substantially decline from current levels, and we maintain our stable outlook on the industry. For an upgrade we expect Key to maintain debt leverage under 3.75x through most points in the industry cycle. However, much of the exploration and production industry, Key's customer base, remains cautious about 2013 capital spending levels because of uncertainty over the U.S. political and regulatory environment following the November elections and the impact to oil prices from the struggling European and weakened Asian economies. We expect to review Key in the first half of 2013.
We could stabilize ratings if market conditions significantly decline such that Key's ability to maintain its above-average financial measures is tested by either market conditions or financial policy. One challenge might be aggressive capital spending if market softening persists, such as that debt leverage would exceed 4x.
Related Criteria And Research -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- Corporate Ratings Criteria 2008, published April 15, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Ratings List Ratings Affirmed; Outlook Revised To Positive To From Key Energy Services Inc. Corporate Credit Rating BB-/Positive/-- BB-/Stable/-- Senior Unsecured BB- Recovery Rating 4
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