DBRS Confirms Finning International at A (low) and R-1 (low)

DBRS has today confirmed the long-term and commercial paper ratings of Finning International Inc. (Finning or the Company) at A (low) and R-1 (low), respectively. The trends are Stable. The ratings primarily reflect Finning’s strong business risk profile as a leading dealer of Caterpillar Inc. (CAT) equipment, with well-diversified revenue and a strong customer support services business that helps reduce the impact of cyclical industry downturns on operating results.

Finning’s financial profile weakened over the past year, mainly from higher debt and modestly lower earnings and cash flow. However, the Stable trend is based on the assumption that the Company will generate solid free cash flow in 2009 and materially reduce leverage to the low end of Finning’s targeted net debt-to-capital range of 40% to 50%. While the range is relatively high for the rating category, it is acceptable when excluding implied debt related to the Company’s rental operations (mainly given the highly saleable nature of the underlying equipment). Free cash flow is expected predominantly from working capital, as funding requirements for inventory and receivables decline in line with demand – consistent with Finning’s working capital-oriented business model. In addition, lower net rental investments, which are discretionary, will also benefit free cash flow. While lower earnings and cash flow will result chiefly from slowing new equipment demand over the near term from peak levels in 2008, debt reduction should offset the impact on coverage ratios.

The key challenges facing Finning relate to the volatility in commodity markets and limited macroeconomic visibility, which have led to increased uncertainty regarding the extent of declines in demand for CAT equipment. A steep reduction in commodity prices, namely, oil (Alberta oil sands) and copper (Chile), would negatively affect the Company’s backlog and likely materially reduce operating results. In addition, sustained weakness in macroeconomic fundamentals would further depress demand for construction-related equipment, limit improvement in Finning’s U.K. division (where returns have been weak), and add pressure to the residual value of used/rental equipment. In the event of lower-than-expected operating performance and debt reduction, the ratings could come under pressure as the Company’s financial risk profile would no longer be viewed as acceptable for an A (low) rating.

Despite the aforementioned risks, DBRS does not expect a sharp deterioration in earnings and cash flow over the near term. Steady growth in sales over the past several years has led to a large installed base of CAT equipment, which is expected to support continuing growth in Finning’s Customer Support Services (CSS) business (which has increased to 32% of total revenue). CSS sales are expected to continue to generate margins well above new equipment sales, with limited exposure to cyclical swings in demand, which adds stability. The Company maintains a dominant CSS market share in its most profitable regions and, while commodity pricing and economic conditions sharply deteriorated in late 2008, Finning has not witnessed any material signs that trucks are being parked by their customers (activity in the Canadian oil sands and copper mining in Chile remains robust). While the near-term outlook has weakened, the medium- to longer-term fundamentals in these markets do remain solid and the cash cost of production of most of Finning’s mining customers is well below current commodity prices. From a liquidity standpoint, the Company is well positioned, with no material debt maturities until 2011. Additionally, future rental investments are expected to be well below previous high levels, which should reduce balance sheet pressure when industry demand rebounds.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Industrials, which can be found on our website under Methodologies.

This is a Corporates rating.