OREANDA-NEWS. August 31, 2015. Fitch Ratings has downgraded Anton Oilfield Services Group's (Anton) Long-Term Issuer Default Rating by two notches to 'B-' from 'B+'. At the same time, Fitch has also lowered Anton's Recovery Rating to 'RR5' from 'RR4', and the senior unsecured rating on the company's USD250m 7.5% bonds maturing November 2018 to 'CCC' from 'B+'. All ratings are placed on Rating Watch Negative (RWN).

The rating actions reflect Anton's tighter liquidity and elevated refinancing risk, which are evident in its results for the first six months of 2015. Anton's credit risk has increased with working capital needs that continue to be high despite a drop in revenue from 2014; a material reduction in cash balances; and a significant amount of debt, including unutilised credit facilities, maturing over the next 12 months.

While Anton has managed to expand its order book in 1H15, much of that growth has been from overseas, including Iraq and Ethiopia, which come with higher geopolitical risks despite potentially wider margins. At the same time, the operating environment in China remains extremely challenging. We expect the industry conditions to remain weak due to significant near-term pressure on oil prices. We also see limited potential for the company to further pare costs, beyond the sizeable cost savings achieved in 1H15.

KEY RATING DRIVERS

Tight Liquidity: Anton used cash-on-hand to pay down CNY300m of domestic bonds that matured in May 2015, even though it originally planned to seek refinancing. Its working capital conversion cycle continued to be lengthy at 303 days during 1H15 (1H14: 219 days), while committed capex payments for equipment remained considerable with CNY168m spent in 1H15. As a result, cash on hand declined substantially to CNY265.1m at end-June 2015 from CNY759.8m at end-2014.

Debts that are due to mature in the next 12 months include about CNY330m of unsecured domestic short-term borrowings and CNY200m of domestic bonds maturing in August 2016. The company's ability to meet its debt maturities and other obligations, including estimated monthly fixed expenses of CNY100m-120m and interest payments, is highly dependent on further improvement in receivables collection and the availability of sufficient credit facilities. The company had undrawn credit facilities of CNY563.6m at end-June 2015; however, we understand that these facilities need to be rolled over in 2H15.

Risks To Overseas Exposure: Anton has turned to markets overseas to offset the impact of the sluggish domestic market. Large overseas contracts, especially in Iraq, have driven the order book to CNY2.8bn at present from CNY1.7bn at end-2014. Iraq's contribution to Anton's revenue has increased to 33% in 1H15 from 16% in 2013, and could rise further based on its estimated 40% share of the current order book. Anton also has a CNY200m contract in Ethiopia. Although the overseas contracts have enhanced Anton's geographical diversity, and offer higher margins than domestic ones, they carry higher geopolitical risk, and Anton faces stiff competition in many of its overseas markets. The overseas contracts, however, help the company's operating cash generation, which has been significantly affected by conditions in China.

Challenging Industry Conditions: The subdued and volatile oil prices have resulted in project shrinkage or delays in 1H15. Fitch does not expect the situation to improve significantly in the next 12 months given the capex cuts by many oil majors, including those in China, which is Anton's core market. New project opportunities increasingly are available in riskier emerging markets. In addition, in China, independent service providers are now at a disadvantage compared with the in-house service arms of the state-owned enterprises. While Anton was able to secure new orders in China, most of these were at margins thinner than historical levels.

Cost Efficiencies: Anton has taken steps to improve cost efficiency, including staff cuts. The ratio of selling, general and administrative (SG&A) expenses to revenue dropped to 23.3% in 1H15 from 34.6% in 2H14, though they remain higher than the historical level of around 20% (19.8% in 2013). Fitch believes further significant improvement in this ratio is unlikely, as fixed costs at current levels would be required to support execution of Anton's orders.

Recovery Rating Lowered: Given the material impairment in cash flow generation and the stress that would place on the realisable value of assets in the event of liquidation, we now see heightened prospects for lower-than-average recovery for Anton's senior unsecured credits. As such, the Recovery Rating on Anton's senior unsecured obligations was lowered to 'RR5', from 'RR4' previously.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Revenue in 2015 to decline marginally while gross margin to remain steady, with a marginal improvement expected thereafter
- Working capital cycle to marginally improve
- Capex of CNY400m in 2015

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
- A further tightening of liquidity resulting from non-availability of adequate bank credit lines, failure to maintain adequate cash balances, deterioration in cash conversion cycle, or higher-than-expected capital expenditure payments

Positive: Future developments that may, individually or collectively, lead to the ratings being affirmed at the current level with a Stable Outlook include:
- An ability to maintain sufficient liquidity resulting from successful renewal of bank credit lines of an adequate amount, refinancing of long-term debt maturing in the next 12 months, improvement in working capital conversion cycle, and accumulation of unrestricted cash balances; and
- A general improvement in operating conditions supporting the company's ability to maintain a financial profile adequate for a Long-Term IDR of 'B-'.