Overview -- We expect Tervita Corp.'s 2012 debt-to-EBITDA to deteriorate above 6.5x through the next 12 months due to soft industry conditions, which will lead to weaker-than-expected EBITDA generation. -- We are revising our outlook on Tervita to negative from stable. -- We are affirming our 'B' long-term corporate credit rating. -- The 'B' issue-level rating on the company's senior secured debt, and its 'CCC+' issue-level ratings on Tervita's unsecured and subordinated debt are unchanged, as are the '3' and '6' recovery ratings on the secured and unsecured debt, respectively. -- The outlook revision reflects our view that Tervita's EBITDA through the second half of 2012 and into 2013 will be significantly lower than expected due to lower drilling activity and weather-related issues. Rating Action On Oct. 4, 2012, Standard & Poor's Rating Services revised its outlook on Calgary, Alta.-based Tervita Corp. (formerly CCS Corp.) to negative from stable. At the same time, Standard & Poor's affirmed its 'B' long-term corporate credit rating on Tervita, its 'B' issue-level rating on the company's senior secured debt, and its 'CCC+' issue-level ratings on Tervita's unsecured and subordinated debt. The '3' recovery rating on the secured debt and '6' recovery rating on the unsecured and subordinated debt are unchanged, and indicate our expectation of meaningful (50%-70%) and negligible (0%-10%) recovery, respectively, under our default scenario. Standard & Poor's had expected Tervita to generate significant EBITDA in 2012 such that debt-to-EBITDA would improve below 5.7x at year-end 2012. However, lower drilling activity combined with wet weather and delays in facilities coming online have reduced our expectations for the company's 2012 and 2013 EBITDA. We forecast 2012 EBITDA to be C$370 million-C$400 million, down from our original expectation of C$420 million-C$450 million; we project Tervita to end 2012 with about 7.0-7.5x debt to EBITDA. We, however, expect debt-to-EBITDA to improve but remain elevated above 5.5x in 2013. Rationale The ratings on Tervita reflect Standard & Poor's view of the company's "fair" business risk profile and "highly leveraged" financial risk profile. Our ratings take into account the company's high debt leverage due to management's aggressive financial policy, participation in the competitive and cyclical oilfield services market, and lack of long-term contracts. The ratings also incorporate our positive assessment of Tervita's relatively stable operating margins and integrated strategy that provides cross-selling opportunities. In our opinion, the company's financial risk profile constrains the ratings. Tervita is an integrated environmental service company that provides services in various fields, including but not limited to energy-related waste management, environmental remediation, and well servicing. Most of its operations are in western Canada (85% of gross profit), with some in the U.S. As of June 30, 2012, the company had about C$2.58 billion in adjusted debt (adjusted mostly for operating leases and asset-retirement obligations), compared with C$2.38 billion of balance-sheet debt. In our view, Tervita's highly leveraged financial risk profile, which reflects its high debt-to-EBITDA ratio and large cash flow requirements to service its fixed charges, constrain the ratings. The company finished 2011 with about a 6.9x debt-to-EBITDA ratio; given our revised assumptions for Tervita's 2012 results, we expect the company to finish 2012 with about a 7.0x-7.5x debt-to-EBITDA measure. We forecast the company to end 2013 with 5.5x-6.5x debt-to-EBITDA. We estimate its annual fixed charges (maintenance capex, debt amortization, and interest expense) at C$300 million-C$350 million annually for 2012 and 2013, which is high compared with 2011 EBITDA of C$340 million and our expected 2012 EBITDA of C$370 million-C$400 million. We view management's financial policy as aggressive. We believe Tervita's financing of capital expenditure plans through debt for the past few years and management's plan to improve credit measures through EBITDA growth instead of debt reduction as risky. Although the company's EBITDA has improved marginally, additional debt on the balance sheet to fund capex has hindered significant improvement in its credit measures and constrained return on capital at less than 3%. Tervita will spend C$650 million-C$700 million in capex in 2012-2013; it will fund 2012 capex partially through additional debt but plans to keep 2013 capex within cash flow. Given the additional debt, we expect the company's debt-to-EBITDA to remain above 7.0x through 2012 and 5.5x through 2013. Tervita's EBITDA and revenue generation depend largely on the highly volatile oil and gas industry in the North America market. About 75%-80% of the company's revenues are exposed to that industry, and we expect the proportion to stay the same. We believe that Tervita's exposure to North America also exposes it to the volatility of its clients' capital budgets and operations, which can be pulled back in times of weak commodity prices. Lower drilling rig count and E&P companies' reduced capex plans are significant factors in Tervita's lower forecast EBITDA in second-half 2012; in addition, wet weather and delay in bringing some facilities online have also stressed EBITDA generation. Furthermore, as is typical for the services, the work the company's conducts for customers is not contracted; instead, there are pricing agreements with no guarantees for minimum volumes. We believe that Tervita's cash flows are vulnerable to a sudden loss in revenues should customers scale back operations, decide to perform the services themselves, or use services from a competing firm. The company supports production activities (about 65% of revenues), rather than drilling-related activities, which mitigates the volatility in its profitability to some extent. We expect operating margins to remain relatively stable in trough industry conditions when compared with that of other companies exposed to the oil and gas sector. Tervita's fluids and solids services segments generate stable margins (about 65% of the company's total gross profit), despite some volume fluctuation. In the past five years, including the 2008-2009 downturn, Tervita's EBITDA margin (total EBITDA divided by total revenues less marketing revenues) ranged from 26%-30%, compared with 14%-35% (trough-peak margins) for other oilfield service companies. In our view, Tervita's recent strategy of marketing all its business segments under one umbrella, instead of a fragmented method, should enhance its diversification. Management's integrated marketing approach and the opportunity to cross-sell different servicing opportunities in the currently beneficial industry condition (horizontal drilling and associated pressure pumping) should facilitate the company's revenue and EBITDA growth. For 2012 and 2013, we have forecast the following: -- Gross profit and EBITDA growth of 15%-25% in 2012 and 2013. -- Tervita will spend C$650 million-C$700 million in capex for 2012 and 2013. -- Most of the growth is from the fluids services and Tervita U.S. segments. Based on our assumptions, the company will end 2012 with a 6.7x-7.2x debt-to-EBITDA and 2013 with a 5.5x-6.5x debt-to-EBITDA. We believe EBITDA interest coverage will remain below 2.5x through 2013. Our assumptions do not forecast that Tervita will complete an IPO in this period but we expect credit measures to improve significantly provided the company uses any potential IPO proceeds to pay down debt. Liquidity We believe Tervita's liquidity is adequate. Sources of liquidity can cover the company's near-term needs, even in the event of unforeseen EBITDA declines. Our assessment of Tervita's liquidity profile incorporates the following expectations and assumptions: -- We expect the company's sources of liquidity, including proceeds from the new notes offering, FFO, cash, and facility availability, to exceed its uses by 1.2x in the next 12 months. -- We expect net sources to remain positive even if EBITDA declines more than 15%. -- Compliance with financial covenants will survive a 15% drop in EBITDA, in our view. -- Due to the refinancing risk associated with Tervita's bank debt, we believe the company would be unable to absorb low-probability, high-impact shocks. Tervita's sources of cash include about C$9.8 million of cash on hand as of June 30, 2012. It had about US$161.3 million and about C$39 million available under its U.S. and Canadian senior secured credit facility, respectively. Although the company has a large capital budget of C$650 million-C$700 million in 2012 and 2013, we expect it will be able to fund it through cash from operations and revolver borrowings. In the case of a downturn, we expect Tervita to be able to pare back its capital expenditure plans meaningfully to manage its liquidity and limit outspending its cash flow. The credit facility has maximum secured debt-to-EBITDA of 5.75x financial covenant. As of March 31, 2012, the company's reported of the covenant at 4.18x, which provides adequate cushion (about 27% of EBITDA drop) in case of a downturn. Recovery analysis For the complete recovery analysis, see "Recovery Report: CCS Corp.'s Recovery Rating Profile," published Jan. 11, 2012, on RatingsDirect on the Global Credit Portal. Outlook The negative outlook reflects our view that Tervita's credit measures will remain elevated at above 7.0x debt-to-EBITDA as it exits 2012. Despite improved EBITDA compared to 2011 levels, due to additional debt on the balance sheet, the company's debt-to-EBITDA will remain elevated throughout our forecast period. We deem Tervita's leverage metric as high relative to its overall business risk profile and we regard management's financial strategy as risky. At current EBITDA and debt, the company has little flexibility in adding debt without affecting the ratings. We would downgrade Tervita if the company is unable to generate improved cash flow so that expected debt-to-EBITDA ratios stays within 7.0-7.5x through first-quarter 2013, without any positive trend. This could also occur if 2013 gross profit grows less than 15% from 2011 level. Also, debt-financing of growth initiatives, either acquisition or capital expenditures, without prospects for rapid deleveraging, could lead us to revisit our ratings and outlook on Tervita. A deterioration in its liquidity position could also compromise the ratings. An outlook revision to stable for Tervita would depend on an improving financial risk profile, For example, if the company's debt-to-EBITDA improves to 5.0x-5.5x by reducing debt post-IPO. From an operational perspective, if we expect Tervita to demonstrate continued EBITDA growth, either through lower overhead costs or more cross-selling opportunities, such that we expect debt-to-EBITDA to improve below 5.5x, we could revise the outlook to stable. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 -- Key Credit Factors For Global Oilfield Services Companies, May 31, 2006 -- Global Oilfield Service Company Characteristics and Keys to Success, Jan. 11, 2005 Ratings List Tervita Corp. Outlook Revised To Negative To From Corporate credit rating B/Negative/-- B/Stable/-- Ratings Unchanged Senior secured debt B Recovery rating 3 Senior unsecured debt CCC+ Recovery rating 6 Subordinated debt CCC+ Recovery rating 6 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.