OREANDA-NEWS. September 07, 2015. Fitch Ratings says today China's independent oilfield services (OFS) companies are set to continue to face challenges in the next 12 months. Liquidity management has become a critical issue for the smaller Chinese OFS companies, while many companies are turning to overseas markets, which typically come with higher geopolitical risks, to make up for the fewer opportunities at home.

Most Chinese OFS companies' revenue and margins fell during 1H15 as upstream exploration & production (E&P) companies reined in capex, cut back on projects and reduced rates for the OFS providers. For the independents, gross margins on domestic projects have dropped to around 20% from over 30% historically, and Fitch believes such lower levels will persist until oil prices see a meaningful upturn, although for many, domestic margins are unlikely to return to historical levels, even if oil prices increase materially.

Anton Oilfield Services Group's (Anton; B-/Rating Watch Negative) revenue fell 23% in 1H15 from a year earlier, China Oilfield Services Limited's (COSL; A/Stable) dropped 24% and SPT Energy Group Inc.'s (SPT) decreased 53%. All three companies also reported thinner margins; and SPT reported an EBITDA loss.

Among the publicly listed independent Chinese OFS companies, an exception was Petro-King Oilfield Services Ltd (Petro-King), whose 1H15 revenue increased by 18% and EBITDA margin widened to 19% from 13% a year earlier. This was driven by a 61% rise in revenue from overseas markets, including Iraq (B-/Stable). Chinese OFS companies are increasingly turning to overseas markets, mostly emerging ones. Anton's overseas revenue increased by 27% yoy during 1H15, as new contracts from Iraq and Ethiopia (B/Stable) drove the company's order book growth over the last few quarters.

Projects in overseas emerging market usually offer higher margins, and therefore are attractive for Chinese OFS companies facing a weak domestic market. Nonetheless, most of these new markets have much higher geopolitical risks, and in some cases, higher counterparty risks. In 2014, Petro-King wrote off CNY280m, or 28% of its 2013 receivables, in Venezuela (CCC). Competition is also keen for contracts in these markets.

The Chinese OFS companies have taken steps to improve cost efficiencies, especially staff expenses, which represent the single largest operating cost item. COSL cut its sales and administrative expenses by 12% in 1H15, Anton reduced the same by 15%, SPT by 15% and Petro-King by 8%. Fitch believes further substantial cost cuts would be difficult for companies, given the need to support their current order books and expanded overseas operations.

Despite the cost cuts, many Chinese OFS companies' net cash generation has been hurt by continued high working capital requirements - due largely to longer receivable days, as well as capex, although this has been reduced from peak levels for most. While Anton and Petro-King have both experienced quicker receivable collection during 1H15 compared with 2H14, at 284 days and 356 days respectively, their turnover cycle is still slow. COSL and SPT experienced a slower receivables turnover during the period.

Capex also remained high for many companies. Anton had capex of CNY167.7m for payment of previously ordered equipment, relative to its negative operating cash flow of CNY32.5m. SPT's capex was CNY110.0m compared to operating cash flow of CNY48.7m. COSL reported a 48% yoy increase in capex for several equipment construction projects that it started previously.

Amid the subdued market conditions, limited room for cost cuts and slow receivable collection, Fitch believes liquidity management is critical for the OFS companies to weather the storm. For COSL, its affiliation with the state-owned China National Offshore Oil Company ensures strong access to capital, and continues to cushion to its 'A' rating against deterioration in its standalone profile. However, many small independents are facing heightened liquidity challenges. Fitch recently downgraded Anton to 'B-' from 'B+' with all ratings placed on Rating Watch Negative, primarily because of the significant deterioration in the company's liquidity position. Continued access to funding, especially from the banking market, will be critical for Anton in the next 12 months.