DBRS Confirms Transcontinental Inc’s Ratings at BBB (high), Pfd-3 (high), Stable Trends

DBRS has today confirmed its long-term and preferred share ratings on Transcontinental Inc. (Transcontinental or the Company) at BBB (high) and Pfd-3 (high), respectively. The trends are Stable. While DBRS acknowledges that Transcontinental could ultimately lose the benefits that keep its rating above the average for the printing industry, DBRS is mindful that Transcontinental continues to use its capabilities to grow in printing and other related areas and is committed to reducing leverage to historical levels as its capital investments gradually reach completion. Bolstered by new contracts, this growth has begun to add to cash flow from operations. These advantages support the assigned BBB (high) rating.

The confirmation reflects four factors. First, while Transcontinental’s operations have experienced some EBITDA pressure in F2009 (down 3.4% on a reclassified basis to $349.3 million) as a result of the downturn in the economy, the Company reacted quickly relative to its peers, putting in place a number of rationalization efforts. This can be seen in the last-twelve-month (LTM) period, where EBITDA grew by nearly 7% to $373.4 million, despite continued revenue pressure. This rationalization effort has positioned the Company for growth for the next couple of years as new contracts ramp up and add to generate revenue and EBITDA and as the economy improves. As a result, EBITDA is expected to rise in F2010, even excluding the Company’s U.S. direct mail operations, which were divested on April 1, 2010, for proceeds of US$112.5 million.

As such, DBRS believes that, for the most part, the pressure Transcontinental has experienced in F2009 is cyclical in nature, with structural factors affecting only a small portion of its businesses (for example, its recently divested direct mail business in the United States). Although DBRS’s rating philosophy is based on rating companies through an economic cycle, should these factors or any competitive pressures become more permanent and structural in nature, DBRS could deem some impairment to Transcontinental’s current business risk profile and reassess the rating.

Second, despite the impact of the economic downturn on Transcontinental’s operating segments, the Company continues to benefit from its niche-oriented strategy and diversification (it holds several non-printing-based operations). These factors differentiate Transcontinental from peers that focus exclusively on more competitive parts of the printing industry and related activities. In addition, the Company continues to leverage its expertise and capabilities into creating new services for its customers such as its outsourced printing solutions for newspaper publishers (notably, the San Francisco Chronicle, The Globe and Mail and La Presse) and the enhancement of its Marketing Communications division as it vertically integrates itself to handle more aspects of its customers’ changing media and advertising needs. While this division remains small, DBRS believes that it is geared toward the direction marketing is heading in a multimedia world, and that capabilities procured in this sector could have benefits in Transcontinental’s more traditional printing and media segments.

Third, capex levels, after peaking in F2009, are expected to decline in F2010 and further in F2011 as the Company completes the investment phase of its projects and revenue and EBITDA begin to flow. This process is already underway and has returned the Company to a free cash flow position ($8.3 million in LTM F2010), which should improve for the remainder of F2010 and into F2011. This free cash flow is expected to be used to reduce Transcontinental’s leverage – which had increased to fund these projects – to more historical levels. Evidence of this has already been seen in Q1 F2010, with net debt-to-EBITDA improving to 2.4 times, which is now within the Company’s target range of 2.0 times to 2.5 times. DBRS prefers Transcontinental to be at the lower end of its 2.0 times to 2.5 times net debt-to-EBITDA target.

Fourth, after successfully obtaining both necessary and opportunistic financing in F2009, Transcontinental has a manageable maturity profile. It has modest amounts of debt maturing in F2010 and F2011, while its A/R securitization program matures this summer (August 2010). DBRS believes that the Company will renew the A/R securitization program in the near term. Beyond F2011, DBRS notes that Transcontinental has large maturities in F2012 and in F2014, including its credit facility that matures in F2012.

DBRS remains cautious regarding Transcontinental’s largest segment, printing, as capacity in the industry is still abundant and competition remains intense. However, DBRS notes that Transcontinental appears to have been relatively successful at insulating itself against some of the current structural trends affecting the industry (and particular sectors) by keenly staying focused on the changing needs of its customers. Furthermore, DBRS will continue to monitor the Company’s results in its Media and Marketing Communications segments, which should benefit from a recovery in the economy in the medium term and be positioned to adapt to and take advantage of new forms of media over the next few years.

DBRS expects improved results from Transcontinental over the next couple of years. This includes: (a) an expectation of some form of economic growth; (b) a relatively stable business risk profile; (c) a return of free cash flow and leverage to more historical levels in F2010 and F2011.

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

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

This is a Corporate (Telecom/Media/Technology) rating.