DBRS Confirms Finning at A (low), Trend Stable

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 product support business that helps reduce the impact of cyclical industry downturns on operating results. The Company’s financial profile remains in line with the rating, demonstrated by improved financial performance and metrics in 2010, as well as its solid liquidity with $350 million in cash and over $1 billion in available credit lines.

Despite being affected by the recession for the first half of 2010, the Company’s financial performance improved year-over-year as market activity picked up momentum in H2 2010 and led to higher-than-expected results. The shift in revenue mix to a higher proportion of product support business (which generates significantly higher margins), as well as productivity and efficiency initiatives, resulted in higher EBIT margins year-over-year. However, margins were pressured by the strength of the Canadian dollar and high labour costs in South America.

In May 2010, the Company completed the sale of Hewden Stuart Plc (Hewden), its U.K. rental business, which strengthened the Company’s business model, allowing it to focus its attention and resources on its core business. Due to the working capital orientation of the Company, softer demand for new and used equipment (in the first half of the year) resulted in decreased working capital requirements, helping to generate solid free cash flow. Free cash flows and proceeds from the sale of Hewden were used to reduce debt levels in 2010, resulting in an improvement in the financial profile to levels more commensurate with the rating.
Going forward, Finning is expected to generate solid growth in revenues and EBITDA in the near term in light of recovering general economic activity, as well as market share growth. New-equipment sales are expected to be strong in 2011, supported by a $1.3 billion order backlog (at December 31, 2010), the highest level since Q4 2008. Demand for equipment is backed by strong commodity prices (oil, copper, gold, coal, etc.), which will continue to drive mining growth in Canada and South America. Market conditions are also expected to continue to improve in the construction and power system sectors. Finning is investing heavily in product support infrastructure in western Canada to support oil sands activity. This will allow the Company to strengthen its leading position in mining and oil sands and capture significant product support opportunity in the longer term. With high levels of installed base of CAT equipment, Finning’s revenue mix is expected to remain fairly constant in 2011 relative to 2010, with product support generating around 45% of revenues. This will continue to add stability to the Company’s financial profile by limiting exposure to cyclical swings in demand. EBIT margins are also expected to improve, with the Company’s continued focus on a lower cost structure as well as productivity and efficiency initiatives. However, overall margins will be pressured by a strong Canadian dollar while South American margins will be negatively affected by a very competitive labour market, rising inflation and strengthening local currency.

In line with higher earnings and cash flow from operations, Finning is expected to generate positive 2011 free cash flow (before working capital), despite significantly higher capex spending, increased levels of net rental additions and the possibility of higher dividends. However, with elevated levels of demand for new and used equipment, working capital requirements are expected to increase, resulting in a modest free cash flow deficit. DBRS expects that this deficit could either be funded with cash on hand (the Company had $350 million at the end of 2010) or very modest levels of additional debt. DBRS notes that the timing of ordering and delivery related to market activity could result in significantly higher negative free cash flow during the first half of the year; this deficit, however, should shrink considerably in the second half of the year when deliveries are made and customer payments are received.

The Company is focused on using its resources for growth as opposed to further debt reduction; as such, Finning is expected to refinance and term out a significant portion of its upcoming 2011 maturities, which will provide added financial flexibility. Higher earnings and relatively constant debt levels in 2011 are expected to result in improved coverage ratios and stable leverage metrics, keeping Finning’s financial profile in line with the A (low) rating. In view of strong market conditions and the Company’s objectives toward growth, DBRS expects the ratings to remain stable in the near to medium term.

Note:
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.