DBRS Confirms Superior Plus LP at BB (high), Stable

DBRS has today confirmed the Issuer Rating on Superior Plus LP (Superior or the Company) at BB (high) and the Instrument Ratings of the Senior Secured Notes and Senior Unsecured Debentures issued by Superior at BB (high) and BB (low), respectively. Trends on all the ratings are Stable. Pursuant to DBRS’s leveraged finance rating methodology, the recovery ratings of RR3 and RR6 on the above-noted securities are confirmed. Superior is a 99.9%-owned subsidiary of Superior Plus Corporation (SP-Corp), which was converted from an income fund at year-end 2008 and is listed in the Toronto Stock Exchange. As SP-Corp has no other operating business, Superior’s business cash flow is used to support all consolidated debt. Hence, we have assessed the consolidated financial metrics and liquidity in determining Superior’s financial risk profile.

The Company has been acquisitive in the past as it sought to grow its revenue, geographic reach and customer base. However, performance of the acquired companies have been below expectation, largely as a result of the slow economic recovery and housing starts in North American since the recession in 2009, occasional impact of unusually warm winters that reduce demand of propane and heating oil, as well as the more intense competition in the Energy Services (ES) and Construction Product Distribution (CPD) segments in the U.S. compared to the Canadian home markets. In addition, the sodium chlorate production within the Company’s Specialty Chemicals (SC) division is mainly sold to the pulp and paper industry, which is facing fundamental decline in demand in North America. We expect the headwinds facing Superior’s businesses in North America to persist and limit future volume growth prospects.

The slower-than-expected growth in earnings and cash flow and the increased debt level to finance these acquisitions have combined to result in materially weaker debt coverage metrics since 2007 to levels that DBRS considers weak for the current BB (high) rating. Adjusted debt-to-EBITDA peaked in 2010 at 5.9 times (x), while cash flow- to-debt weakened to 11%. These metrics have begun to improve since then as the economic conditions slowly recover to 4.5x and 16%, respectively, for the last 12 months ended June 30, 2012.

DBRS notes that Superior has adopted a number of measures to improve its financial risk profile following the appointment of the new CEO, Mr. Luc Desjardin, in November 2011. These measures focus mainly on (1) reviewing operations to improve efficiency and reduce operating costs, (2) reducing working capital requirement and stabilizing the enterprise resource planning system installed since April 2010 and (3) conserving cash flow for deleveraging by reducing dividend payments and more focused capex spending. Management has publicly stated its intention to apply its free cash flow toward repayment of outstanding credit facility drawdown until the Company reaches its target of lowering its unadjusted total debt-to-EBITDA to the low end of the 3.5x to 4.0x range and maintain that in the medium term. The efforts have so far led to the notable debt reduction of almost $200 million during the first half of 2012, which contributed to the aforementioned improvements in financial metrics. Given the slow revenue growth prospects, we believe that the Company’s ability to sustain these efficiencies and deleveraging efforts as an important driver of financial metrics and future rating trend. Specifically, DBRS estimates that it would possibly take two more years before these metrics improve to return to their 2007 levels of 3.5x and 22%, respectively, which we consider more consistent with a low-investment-grade financial risk profile.

SP-Corp’s liquidity remains reasonable. After the full redemption of the $175 million of 5.75% convertible subordinated debentures in early August 2012, scheduled debt repayments will be modest, averaging less than $100 million each year until 2015, when the credit facility expires in June and the $74 million convertible debentures mature in October. The Company relies substantially on the $570 million credit facility ($317 million available as at June 30, 2012) and its annual operating cash flow of about $200 million for liquidity. This is more than adequate to cover the projected capital expenditure and its reduced dividend level and allow gradual and steady deleveraging in the coming years.

Superior’s overall business risk profile is supported by its leading market position in Canadian propane distribution and sodium chlorate production and by the diversity provided by other businesses, which reduce its dependence on the North American markets and to specific customer segments. Business volumes in the ES and SC divisions have been steady, albeit slow-growing. Although prices of the distributed products could fluctuate, Superior is able to generate a steady revenue base as it typically earns a fixed-dollar margin over product and transportation costs in ES’s propane and refined fuel distribution business, while a material proportion of SC’s sodium chlorate sales are covered by contractual arrangements. The increasing contribution of chloralkali products in the SC division should improve business diversity and reduce the division exposure to the pulp and paper industry.

DBRS considers the business risk profile of the Company’s smaller CPD business materially weaker than those of the other segments. The CPD market is fragmented with intense competition, largely based on price, service and customer relationship, with a generally low barrier to entry. Demand is also cyclical and dependent upon general economic conditions and housing starts. As the North American economic recovery and housing starts (in particular those in the U.S.) remain slow since the recession in 2009, discounts in sales have been common, resulting in materially lower operating margins. Operating margins in ES have weakened since 2010 as Superior expanded in the more competitive, albeit larger, U.S. markets through acquisitions. In view of the above, we believe that significant material increase of the higher-risk CPD market business or further expansion of the ES business in the U.S. could further weaken Superior’s overall business risk profile and pressure the ratings.

The Stable trend on the ratings reflect DBRS’s view that, given that the current financial metrics are weak for the rating, it will take sustained management effort and more time before they return to levels supportive of a low-investment-grade financial risk profile, despite the recent improvements. On the other hand, we expect that, given their publicly stated intention to delever, management will continue its efforts to prevent deterioration of the Company’s financial profile, as happened in the years leading to 2010. We also expect industry fundamentals, Superior’s business mix and overall business risk profile to remain largely unchanged in the medium term.

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

The applicable methodologies are Rating Companies in the Industrial Products Industry (June 2011) and DBRS Criteria: Rating Leveraged Finance (June 2011), which can be found on our website under Methodologies.