OREANDA-NEWS. S&P Global Ratings today lowered its long-term corporate credit rating on Swedish conglomerate Stena AB to 'BB-' from 'BB'. The outlook is negative.

We lowered issue rating on the $350 million senior secured notes and the $650 million term loan B to 'BB' from 'BB+', one notch higher than the corporate credit rating. The recovery rating is '2', indicating our expectation of substantial recovery for creditors (70%-90%, higher half of the range) in the event of a payment default.

We also lowered the ratings on Stena's unsecured debt to 'BB-'. The recovery rating is '4', indicating average recovery expectations (30%-50%, lower half of the range).

The downgrade reflects the sharply deteriorated outlook for the oil drilling industry and its potentially long-lasting impact on Stena's business and financial risk. However, we note the effect for Stena is less pronounced than for pure drillers, because it is well diversified in the ferry, shipping, and real estate industries. This should cushion somewhat the impact of the weak drilling activity. Although Stena has relatively limited scale in drilling, with seven units, it reported 2015 revenues of close to Swedish krona (SEK) 36 billion (about $4.2 billion) and EBITDA of SEK11.6 billion (about $1.4 billion).

We anticipate drilling market conditions will continue to deteriorate at least through 2017. The timing of a recovery remains highly uncertain, in our view, because oil companies' drastic cuts to capital spending could hit offshore drilling for several years, even if oil prices recover ahead of our assumptions. The uncertain length of the downturn and uncertainty surrounding any recovery weighs negatively on Stena's future cash flow visibility. Its order backlog and profitability will, in our view, weaken as low contract coverage and unemployed rigs weigh negatively on operating cash flow capabilities and margins.

Stena has nevertheless demonstrated that it can produce fairly stable operating results and generate adequate cash flows through the cycle. A material share of the group's portfolio comprises residential real estate in Sweden, where vacancy levels are low and rents are regulated. This translates into low-risk, very stable, and predictable cash flows. We therefore maintain our assessment of Stena's business risk at fair, despite the weakness in the drilling division.

The negative outlook on Sweden-based conglomerate Stena AB reflects S&P Global Ratings' view that the group's financial performance and credit ratios could be further affected if part of the current existing drilling fleet were to remain unchartered over the next several quarters absent a drilling market recovery. The rating already factors in stability for the ferry, shipping, and property operations in terms of cash flow production together with a good development in Stena's investment business. We anticipate FFO to debt will remain at or above 8% and adjusted debt to EBITDA at about 7x or lower.

We could downgrade Stena, most likely by one notch, if FOCF is materially negative or if EBITDA is lower than our projections, which may occur if several drilling units are unemployed and prospects for new contracts are poor. We could also lower the ratings if Stena's liquidity deteriorates, most likely due to drawings on the revolving credit facility or continued high capex in the context of diminishing FFO. FFO to debt clearly below 8% or debt to EBITDA remaining above 7x could be a downside rating trigger.

Although unlikely in the short term, we could revise the outlook to stable if Stena is able to quickly restore its financial performance, materializing in FFO to debt recovering to close to 10% and debt to EBITDA close to 6x. This could stem from lower investments or an improved situation in drilling.