DALLAS (S&P Global Ratings) Oct. 9, 2017--S&P Global Ratings today removed its ratings on Ensco PLC from CreditWatch with negative implications, where we placed them on May 31, 2017, following Ensco's announcement of its intention to acquire Atwood. The outlook is negative.
We lowered our corporate credit rating on Ensco to 'B+' from 'BB'. At the same time, we lowered our issue-level rating on the company's senior unsecured debt to 'BB-' from 'BB'. We revised our recovery rating on this debt to '2' from '3', reflecting our expectation of substantial (70%-90%; rounded estimate: 85%) recovery to creditors in the event of a payment default.
The downgrade reflects our expectation that Ensco's credit ratios will weaken significantly in 2018 and 2019. Although the Atwood acquisition enhances the size and quality of Ensco's fleet, we expect industry conditions to remain depressed until late 2019 because of the sharp reduction in capital spending by customers in the offshore oil and gas sector. We do not expect the combined
company to realize significant revenue growth from the transaction until the industry recovers. As a result, while Ensco will consolidate Atwood's net debt of about $850 million, we forecast that Atwood's net contribution to cash flow will be minimal over the next couple of years due to its weak contract backlog
and acquisition costs to be incurred in 2018 and 2019.
We assess Ensco's business risk profile as satisfactory. We base our assessment of Ensco's business risk on its large and geographically diversified fleet of high quality, relatively new offshore rigs, and track record of strong operational performance. Following the Atwood acquisition, the fleet has 62 rigs, including 12 ultra-deepwater drillships, 10 dynamically positioned (unmoored)semisubmersible rigs, four moored semisubmersible rigs, and 36 premium jack-up rigs. The rigs listed include three ultra-deepwater drillships and one premium jack-up under construction. The fleet also includes two jack-ups and one semisubmersible that are held for sale or expected to be retired. The company has upgraded its fleet quality over the past several years through newbuilds and rig retirements. Our view is that stacked rigs that are idle or coming off contract over the next few months will not return to work for an extended period. We expect that stacked rigs will not be contracted until a recovery is well under way and may ultimately be retired.
Deepwater units typically receive premium rates during industry upcycles and operate under long-term contracts, providing a cushion of future cash flows during downturns. However, deepwater projects require relatively higher oil prices to generate acceptable returns, and demand for offshore drilling has
fallen sharply. Ensco has one of the largest high quality jack-up fleets in the industry, which operates in shallow water, and is somewhat less sensitive to the effect of low oil prices. Nevertheless, it also facesdifficult market conditions and typically enters into work under shorter-term agreements
(typically a few weeks or a few months). Barring a significant improvement in oil prices and industrywide reduction in rig supply through retirement of older and less competitive equipment, we expect utilization and day rates will be depressed through the first half of 2019, with utilization rates starting
to recover in late 2019 and day rates following in 2020.
The negative outlook reflects our expectation that market conditions in the offshore drilling sector will remain very challenging over the next 24 months. We expect Ensco's credit ratios will be very weak in 2018 and 2019, with FFO to debt around 8% and debt to EBITDA of 9x on average. We could lower the ratings if liquidity weakens, which would most likely result from a more prolonged industry downturn than currently expected and higher-than-expected reactivation expenses or capital spending.
We could consider a stable outlook if offshore contract drilling market conditions improve or the company adds backlog such that we expect debt to EBITDA to improve closer to 6x.