DBRS Confirms Sun Media at BB with a Stable Trend

DBRS had today confirmed the Issuer Rating of Sun Media Corporation (Sun Media or the Company) at BB; its Secured Bank Debt rating at BBB (low), with a RR1 recovery rating; and its Senior Unsecured Notes at BB (low), with a recovery rating of RR5. The trend on all the ratings is Stable.

Although DBRS notes that Sun Media’s business risk profile remains under some structural pressure, it appears to be managing this with significant changes in its cost structure while maintaining a healthy financial risk profile. DBRS also notes that Sun Media’s Issuer Rating continues be constrained by leverage at its parent, Quebecor Media Inc. (QMI), which relies on Sun Media’s distributions, along with cash distributions from other operating subsidiaries, to support its interest costs and funding requirements.

In terms of Sun Media’s business risk profile, DBRS believes that most of the revenue pressure that Sun Media has experienced over the past 30 months remains cyclical, driven by the downturn in the Canadian economy. However, beyond this cyclical pressure, DBRS believes that Sun Media continues to experience ongoing secular trends as advertisers and readers shift to online formats. The Company is attempting to combat this by moving an increasing amount of its content online, ramping up its free daily offerings in most major markets and significantly streamlining its cost structure. Examples of cost reductions over the past couple of years include cutbacks in labour and newsprint use and the creation of an in-house news agency to save on newswire costs. Although advertising revenue remains under some modest pressure, it should stabilize at some point in 2010. DBRS believes that any improvement will be driven by the economy, since structural changes are unlikely to return revenue to prior levels. With significant cost-reduction efforts and despite further revenue pressure, EBITDA improved significantly to $187 million as of June 30, 2010, higher than year-end 2008 but less than year-end 2007.

From a financial perspective, DBRS notes that Sun Media continues to generate good levels of cash flow from operations, with fairly modest levels of capex required. While the majority of cash generated or accumulated is sent to QMI, Sun Media continues to benefit from the significant de-leveraging effort in 2007. Gross debt-to-EBITDA currently stands at approximately 1.80 times and is not expected to exceed 2.0 times going forward. DBRS believes that this level of leverage remains reasonable for a newspaper publishing company, giving it more flexibility through economic cycles.

Although DBRS expects that Sun Media will continue to be affected by structural factors over the medium term, DBRS does not expect revenue pressures to meaningfully increase further, EBITDA to decline significantly nor a significant free cash flow deficit position (after distributions and including cash tax savings) to arise over the next couple of years. Part of this expectation of free cash flow is driven by the variable nature of Sun Media’s distributions to QMI. Despite these expectations, should any of the cyclical and secular pressures on Sun Media intensify beyond DBRS’s expectations and/or leverage fundamentally increase at either Sun Media or QMI, Sun Media’s BB Issuer Rating could be pressured.

DBRS has stressed Sun Media under a default scenario whereby it could possibly default on its debt obligations over the 2010–2013 time frame under certain assumptions. In this default scenario, Sun Media would be in a negative free cash flow position and would require additional debt to fund itself (DBRS has assumed the Company borrows an additional $220 million under a secured credit facility, which is within current headroom under the secured debt test).

At a distressed valuation level, DBRS notes that Sun Media’s Secured Bank Debt (assuming $220 million is outstanding) has outstanding recovery prospects of 90% to 100% under a base-case default/recovery scenario. As such, DBRS has confirmed Sun Media’s Secured Bank Debt recovery rating at RR1 and its instrument rating at BBB (low), two notches above its BB Issuer Rating. This is consistent with DBRS’s leveraged finance rating methodology.

DBRS notes that Sun Media’s Senior Unsecured Notes ($297.8 million outstanding) have below-average recovery prospects of 10% to 30% under a base-case default/recovery scenario. As such, DBRS has confirmed Sun Media’s Senior Unsecured Notes recovery rating at RR5 and its instrument rating at BB (low), one notch below the BB Issuer Rating.

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

The applicable methodologies are Rating Printing and Publishing and DBRS Rating Methodology for Leveraged Finance, which can be found on our website under Methodologies.