DBRS Confirms SaskTel at AA, Stable Trend

DBRS has today confirmed the AA Issuer Rating of Saskatchewan Telecommunications Holding Corporation (SaskTel or the Company), reflecting the long-term rating of the Province of Saskatchewan (the Province). Please see DBRS’s report on the Province of Saskatchewan dated August 25, 2010, for further details.

The confirmation of SaskTel’s rating represents a reflection of the Province’s rating, as SaskTel is an agent of the provincial government of Saskatchewan that ultimately provides creditors recourse to the provincial government. Hence, the provincial rating has been assigned to SaskTel in the form of an Issuer Rating. SaskTel receives the majority of any funding it requires from the Province and does not currently issue its own debt in the capital markets, other than some small credit facilities.

From an operational perspective, SaskTel continues to face many of the same pressures that are affecting other Canadian telecommunications companies (telcos), notably, the shift in its revenue base from higher-margin voice services to lower-margin and more competitive growth services such as wireless, high-speed Internet and video. Competition and technology substitution continue to affect the Company’s traditional fixed-line voice business. Despite this challenge, SaskTel has focused on growth from these new services, which, along with efficiency initiatives, has resulted in only modest pressure on EBITDA. DBRS notes that in spite of these industry trends, SaskTel continues to demonstrate strong market share for its services, with new subscriber growth more than offsetting modest access line erosion. The Company has experienced some near-term pressure on EBITDA and EBITDA margins due to the changing mix of revenue and subscriber acquisition costs associated with signing customers up for new services. This pressure, and the impact from competition, should continue to be largely mitigated by further growth in new services and efficiency measures.

DBRS notes that SaskTel has embarked on a number of multi-year network investment programs that have driven its capex levels higher for 2010 and 2011. This has included a HSPA+ wireless network overlay program, its ongoing next-generation access infrastructure project, pushing fibre deeper into its network, and its rural infrastructure program to provide 100% of the population with high-speed Internet coverage. As such, debt levels have increased in 2010 and will likely continue to rise in 2011 to cover free cash flow deficits during these two years of peak capex levels. DBRS notes that SaskTel has helped to mitigate some of the additional borrowings required with the sale of non-core assets in recent years, with major recent sales netting approximately $70 million in early 2011.

While the Province has committed to support a portion of certain investment programs (such as the Company’s rural infrastructure program), DBRS expects that SaskTel will likely require additional borrowings in 2011 to cover (i) a second year of free cash flow deficits stemming from these investments and (ii) dividend payouts of 80% to 90% of reported net income. DBRS expects this to be manageable given the Company’s strong balance sheet and in light of the expectation that total borrowings will increase by no more than an additional $50 million to $60 million in 2011. As such, although DBRS expects SaskTel’s credit metrics to decline further in 2011, they should remain healthy for a telco, with gross debt-to-EBITDA of roughly 1.5 times, EBITDA interest coverage remaining above 10.0 times and cash flow-to-debt remaining above 0.50 times.

DBRS notes that, currently, any changes in SaskTel’s business or financial risk profiles would have no impact on its credit rating, as it is based on the rating of the Province. The Province’s rating applies to SaskTel as it is a Crown corporation and agent of the provincial government. Without the recourse of the Province, SaskTel’s ratings would likely be investment grade and similar to those of the smaller regional Canadian incumbent telcos. On its own, despite strong market share, SaskTel faces size and scale limitations and generates lower-than-average EBITDA margins. However, this is offset by a healthy balance sheet, good free cash flow generation ability (beyond this investment cycle) and sufficient liquidity.

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

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