DBRS Confirms Transcontinental at BBB (high), Pfd-3 (high)

DBRS has today confirmed its long-term and preferred shares ratings on Transcontinental Inc. (Transcontinental or the Company) at BBB (high) and Pfd-3 (high), respectively. The trends are Stable. The Company’s strong business and financial profile supports a rating well above the general rating for the printing industry.

Transcontinental is the largest printer in Canada and Mexico and the fourth largest in North America, and greatly benefits from its niche-oriented strategy and diversification (by geography, product and customer). The Company’s financial performance was as expected in F2010. Transcontinental demonstrated its commitment to strengthening its balance sheet by reducing leverage as its major capital investments have reached completion. Transcontinental’s financial profile has been bolstered not only by a general improvement in the economy, but also by rationalization measures – making it one the lowest cost producers in the industry – along with a number of new contracts (due to a strong reputation for providing quality products and services), all of which has translated into solid EBITDA growth. Going forward in F2011, the Company is expected to generate considerable free cash flow as a result of significantly reduced capex spending and higher cash flows from operations, which is slated for further deleveraging, resulting in a stronger financial profile. Limiting the upside to the overall rating is the fact that the Company’s business profile may be negatively affected by significant competitive and capacity pressure in its print segment (putting downward pressure on pricing), as well as by structural changes in the industry.

The Company is expected to continue with top-line growth in F2011, with (1) additional new contracts and the full-year impact of F2010 contract signings (i.e., The Globe and Mail, which Transcontinental will continue to print until 2028), (2) growth in the U.S. retail business, with a new facility in California further improving geographic diversification; and (3) a continued increase in market share by leveraging the state-of-the-art technology in its new hybrid printing platform. EBITDA is also expected to increase with ongoing rationalization efforts and synergies from optimization of retail/newspaper platforms. However, growth may be partly offset by forex pressure, as the Canadian dollar is expected to remain strong against its U.S. counterpart.

Transcontinental is expected to generate significant free cash flow in F2011, driven by higher cash flow from operations and considerably lower capex spending. The Company is committed to using free cash flow for the purpose of deleveraging in order to meet its net debt-to-EBITDA (unadjusted for operating leases) target range of approximately 1.5 times. On the back of lower debt levels and higher earnings, the coverage and leverage metrics are expected to continue to improve.

Transcontinental’s liquidity is solid. Availability under its credit facility, cash on hand, an unutilized $200 million accounts receivable securitization program (just renewed in Q2 2011), along with expected strong free cash flow, will be more than sufficient to cover off upcoming F2012 maturities. While the Company’s credit facility expires in September 2012, DBRS fully expects that this line will be renewed in light of ongoing improvement in the Company’s financial performance, which is expected to continue in the near term.

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. With respect to print, the Company has historically pursued niches that generate higher margins (retail, newspaper) while limiting exposure to more competitive segments such as book publishing and commercial. Diversification strengthens the Company’s profile as approximately 30% of revenues are derived from non-print activities (i.e., media and interactive services). 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 and The Globe and Mail) and the enhancement of its Interactive 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 the Interactive sector could have benefits in Transcontinental’s more traditional Printing and Media segments.

Despite Transcontinental’s solid financial profile, DBRS remains cautious regarding its 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 Interactive segments, which are positioned to adapt to and take advantage of new forms of media over the next few years. However, should any competitive pressures become more permanent and structural in nature, DBRS could deem some impairment to Transcontinental’s current business risk profile.

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

The applicable methodologies are Rating the Printing Industry and Rating the Newspaper and Magazine Publishing Industry, which can be found on our website under Methodologies.