DBRS Changes Finning's Senior Debentures and Medium-Term Notes Trend to Positive
IndustrialsDBRS has today changed the trend on Finning International Inc.’s (Finning or the Company) Senior Debentures and Medium-Term Notes to Positive from Stable. The rating is confirmed at BBB (high). Finning’s Commercial Paper rating is confirmed at R-1 (low), with a Stable trend.
The Positive trend is largely reflective of the improvement in Finning’s business risk profile following significant growth in the Company’s customer support services revenues, which are higher margin and relatively stable. In addition, the earnings outlook remains favourable, driven by the robust commodity price environment that DBRS expects will continue to support strong equipment demand (namely in mining and energy), and generally stable economic conditions in Finning’s core markets. DBRS would consider an upgrade in the long-term rating in the event that the Company continues to generate growth in customer support sales and margin improvement, and maintains a relatively stable balance sheet.
After-sale customer support (e.g., parts and services) has become a larger share of Finning’s earnings, following very strong demand for new Caterpillar (Cat)-branded equipment in recent years. This business generates higher margins than the equipment and rental operations, and is expected to become a growing component of Finning’s overall operations. DBRS notes that the rating takes into account the Company’s exposure to commodity and economic cycles, given a customer base based primarily in the mining, construction and petroleum industries in Canada, South America and the United Kingdom. In addition, there is a degree of uncertainty regarding rental residual values on non-Cat equipment during sharp economic downturns, and margins at Finning’s U.K. division, namely Hewden Stuart plc, remain low (but are expected to gradually improve). However, the growing annuity-like nature of customer support services is expected to reduce the impact of historically more volatile equipment sales on profitability during periods of softening demand.
The improvement in Finning’s balance sheet provides additional support for the trend change. Despite large working capital uses necessary to support strong underlying business growth, the Company has generated net free cash flow over the past two years. Debt-to-capital has steadily declined partly from debt repayment, and coverage ratios are strong. Over the near term, working capital uses are expected to increase and more than offset the impact of increased earnings on cash flow. As such, further balance sheet strengthening is unlikely. However, Finning’s leverage includes a significant amount of debt required to support more stable rental operations, and is considered reasonable. In addition, given the counter-cyclical nature of its working-capital oriented business, the Company is expected to generate cash that will be available to reduce debt when equipment demand moderates.
Note:
All figures are in Canadian dollars unless otherwise noted.
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