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 are underpinned by Finning’s strong business risk profile as the world’s largest dealer of Caterpillar Inc. (Caterpillar or CAT) equipment, with both geographic and product diversification and a strong customer support services (CSS) business that helps reduce the impact of cyclical industry downturns on operating results.

The Company’s financial risk profile remains acceptable for the current rating despite the decline in earnings and cash flow from operations in 2009 (relative to strong 2008 and 2007 levels). Weaker operating results were brought on by effects of the economic downturn (e.g., reduced commodity pricing) resulting in lower demand for heavy equipment. However, the impact on credit metrics was partly offset by the working capital orientation of the Company, whereby in periods of softening demand, funding requirements for inventories and account receivables decline in line with demand resulting in significant net free cash flow. In addition, lower net rental investments, which are discretionary, also benefited free cash flow. The Company used net free cash flow to reduce debt levels and improve leverage (albeit still at the low end of the rating range) which largely offset the negative impact on coverage ratios. While 2010 revenues are expected to be slightly lower than 2009 levels, Finning is on track to achieve more than $200 million in annual savings in 2010 compared with 2008 (from cost-reduction initiatives), resulting in a modest improvement in profitability levels year over year.

Although the Company will benefit from the recent resurgence in the mining sector (commodity prices are expected to remain strong), the construction, oil and gas and forestry industries are not expected to rebound until late 2010 and 2011. The impact of the global downturn will continue to be felt into 2010 because of the time lag between new-equipment orders (which have picked up in 2010 as a result of new contracts) and deliveries. However, this should be partially offset by strong CSS revenues (especially in mining) which should mitigate the impact of lower equipment sales on earnings. Steady growth in sales over the past several years has led to a large installed base of CAT equipment, which should support future growth in Finning’s CSS business. 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 Stable trend is based on the assumption that the Company will generate positive net free cash flow in 2010 (even with modest rental and capital expenditures and steady dividend payouts) and continue to reduce leverage to the low end of Finning’s targeted net debt-to-capital range of 35% to 45%. In addition, profitability is expected to improve in the medium term (i.e., 2011), with demand for equipment increasing as industry demand rebounds. Although working capital requirements will likely increase, overall coverage metrics are expected to improve to be more in line with the rating.

The U.K. segment experienced negative EBIT during 2009, reflecting a continued decline in the strength of the underlying U.K economy, particularly in the construction sector. In response to weak operating results at the U.K. rental business, Hewden Stuart Plc (Hewden), the Company undertook significant restructuring and efficiency initiatives. Despite this, earnings are likely to be minimal with high competition, weak demand, and continued pressure on rental rates resulting from overcapacity in the industry. Finning is considering two options with respect to Hewden: (1) continue with a recovery plan to drive operational improvement or (2) dispose of the Hewden operation. DBRS would expect that proceeds of disposition would be used for debt reduction. A decision by the Company is expected at the end of the second quarter of 2010.

From a liquidity standpoint, the Company is well positioned, with no material debt maturities until 2013 and sufficient availability under its credit lines. Additionally, future rental investments are expected to be well below previous high levels, which should reduce balance sheet pressure when industry demand recovers. In the event that the debt does not decline in line with expectations or that earnings and cash flow are substantially lower than expected, the resulting weaker credit metrics could lead to pressure on the ratings.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating the Industrial Products Industry, which can be found on our website under Methodologies.

This is a Corporate (Industrials) rating.