DBRS Downgrades Transcontinental to BBB and Pfd-3, Negative Trends

DBRS has today downgraded the Senior Unsecured Debt rating of Transcontinental Inc. (Transcontinental or the Company) to BBB from BBB (high) and its Preferred Shares rating to Pfd-3 from Pfd-3 (high). Both trends remain Negative, and the ratings are removed from Under Review. The downgrade reflects DBRS’s view that Transcontinental’s earnings profile has been structurally affected by a consumer shift to digital forms of media as the Company has struggled to sustain organic revenues and profitability. The Negative trend reflects DBRS’s view that weakening demand, combined with overcapacity, will continue to place pressure on the Company’s revenues, margins and cash flow generation going forward. DBRS’s concern is not based primarily on the Company’s debt level, as Transcontinental has remained prudent in terms of financial management, but rather the Company’s income and cash generating prospects.

On July 19, 2012, DBRS placed the ratings of Transcontinental Under Review with Negative Implications following DBRS’s update of the methodology Rating the Printing Industry, which involved lowering the Industry Business Risk Rating (BRR). The BRR was reduced from BB (high) to the BB (high)/BB range. The rationale for the methodology change was based on DBRS’s view that the highly competitive industry is being increasingly affected by the structural transition toward digital-based media, applying pressure to traditional printing revenue. DBRS notes that Transcontinental’s ratings were assigned a Negative trend prior to the July 19, 2012, Under Review rating action. In its review of Transcontinental, DBRS focused on the Company’s potential to adapt to the changing environment and assessed the Company’s prospects going forward.

Transcontinental’s organic revenue and operating profit growth began to decelerate in Q2 F2011 and turned negative in Q4 F2011. As such, organic revenue growth has decreased by approximately 3% or $55 million for the 12 months ended July 31, 2012 over the same period prior. Furthermore, organic operating income over the same period has decreased by approximately 11%, or $28 million, primarily due to the expired Census contract and price incentives associated with contract renewals. Transcontinental has reacted to the difficult circumstances facing the industry by focusing on efficiency gains and expanding its product offerings. In terms of top-line growth, Transcontinental recently purchased Quad/Graphics Canada, with the aim of leveraging its customer base. The Company has also aimed to bolster its Media sector through smaller tuck-in acquisitions, in addition to launching and accelerating the development of digital services. That said, the longer-term effectiveness of these initiatives in terms of achieving consolidated organic revenue and EBITDA growth remains difficult to gauge.

DBRS believes the structural declines in the demand for traditional print may outweigh the benefits of Transcontinental’s initiatives, as growth of digital forms of media leads to greater overcapacity and increasing price competition for the printing industry. The Negative trend on Transcontinental reflects DBRS’s view that softer industry demand, combined with overcapacity, will continue to place pressure on the Company’s revenues, margins and cash flow generation going forward.

In terms of financial profile, Transcontinental has remained prudent, preserving credit metrics by using much of its free cash flow over the past two years to repay debt. DBRS notes that the concern it has over Transcontinental’s credit risk profile is not based primarily on the Company’s debt level, but rather the Company’s income and cash-generating prospects going forward.

If the Company’s plans and performance lead to signs of stabilization in organic revenue, and operating income over the near to medium term, the ratings outlook could stabilize. However, a continued and meaningful decline in organic revenue and operating income and/or key credit metrics over this period could result in a downgrade.

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

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