OREANDA-NEWS. Fitch Ratings has affirmed the foreign and local currency Issuer Default Ratings (IDRs) of QGOG Constellation S.A. (QGOG, or HoldCo) at 'BB-' as well as the 'BB-' long term rating on the company's USD700 million of senior unsecured notes due 2019. Fitch has removed the rating from Rating Watch Negative and assigned a Negative Outlook.

The rating action reflects the lower than expected short-term impact from the contracting ban with Petrobras as well as the uncertainty surrounding the timing when the ban will be lifted. The rating action also reflects the better than expected liquidity position as the company reported USD400 million of cash on hand as of March 31, 2015, of which approximately USD255 million was either at the HoldCo or available for distribution. This, coupled with the company's strong cash flow generation with EBITDA of USD624 million during the last 12 months (LTM) ended March 31, 2015, compares favourably with USD346 million of consolidated short-term debt as of the same period.

The Negative Outlook reflects the negative impact a prolonged ban could have for the company as it could prevent QGOG from renewing its contracts with Petrobras. This risk is heightened by the medium-term need to renew some of the company's contracts as they expire. Besides QGOG onshore drilling rig assets, which have relatively short-term contracts, three of the company's operating offshore drilling rigs (OpCos) have contracts that expire over the next two years. QGOG credit quality would be under pressure if it faces difficulties finding new contracts for its drilling rig assets as they expire, namely for Olinda Star, which has a contract that expires at the end of 2015 and is a meaningful contributor of cash flow to the HoldCo.

KEY RATING DRIVERS

Deleveraging to Continue
Consolidated gross leverage, as measured by total debt to EBITDA, for the LTM ended March 31, 2015 reached approximately 4.0x, down from 5.0x as of year-end 2013 as a result of operating company-level debt repayment. Fitch expects QGOG to continue reducing its leverage over the next few years and to lower its consolidated leverage ratio to below 4.0x in the near term. Total debt as of March 31, 2015 reached USD2.4 billion, down from USD3 billion as of year-end 2013, while LTM EBITDA was USD624 million. As of March 31, 2015, debt at the HoldCo level amounted to approximately USD930 million and that at the OpCos was approximately USD1.5 billion.

Structural Subordination
The potential retention of cash flows after debt service at the OpCos' level makes cash flow to the HoldCo less stable and less predictable than the cash flow from operations of the subsidiaries. Some of the project finance debt at the OpCos has cash sweep provisions and minimum debt service coverage ratios (DSCR) (e.g. 1.2 or above) restricting cash flow distributions to the HoldCo. Cash distributions to QGOG are sensitive to the operating performance of the OpCos' (i.e. the rigs) uptime performance. For example, in the case of the Alaskan-Atlantic operating assets, a decline in the uptime rate to 95% or below from the combined 15-year historical average of 96.3% will likely prevent these assets from distributing cash to the HoldCo. Under Fitch's base case assumption of an average uptime rate of 94%, net cash flow distributions to QGOG from its OpCos is expected to average USD300 million over the next three years.

Adequate Liquidity
Constellation's liquidity is supported by a 12-month debt service reserve account and the company's cash on hand, which mitigates possible disruptions of cash flow to the HoldCo from the OpCos due to debt restrictions at the OpCos. As of March 31, 2015, consolidated cash and cash equivalent, short-term investments and restricted cash amounted to USD400 million, of which approximately USD212 million was at the HoldCo level and the balance was at the OpCos. As of March 31, 2015, consolidated cash and cash equivalents at the HoldCo level plus that free of liens amounted to approximately USD255 million.

RATING SENSITIVITIES

Considerations that could lead to a negative rating action (rating or Outlook) for QGOG include a prolonged ban on entering into contracts or participating in bidding processes with Petrobras as well as an overly aggressive growth strategy in the medium term. A positive rating action is not expected in the short- to medium-term. A resolution of the contracting ban with Petrobras could result in revising the Negative Outlook.

LIQUIDITY AND DEBT STRUCTURE

In addition to the aforementioned liquidity position, QGOG benefits from a somewhat stable and predictable cash flow generation at its OpCo level resulting from the long contracting nature of its business and the stable operating performance of the company. Between 2012 and the LTM ended March 2014, QGOG consolidated EBITDA has grown from approximately USD438 million to USD624 million as a result of new operating units coming online during the same time period. Going forward, EBITDA is expected to remain relatively stable with a modest increase in 2015 and 2016 as its latest offshore drilling ship unit, Brava Star, commences operations.

HoldCo's debt of approximately USD930 million as of March 31, 2015 was composed of USD700 million of senior unsecured notes due 2019 and approximately USD230 million of working capital loans with Bradesco due 2017. The balance of QGOG's consolidated total debt of approximately USD2.4 billion was composed of amortizing project finance debt at the OpCos' level.