DBRS Confirms Transcontinental Ratings; Trend Remains Negative

DBRS has today confirmed Transcontinental Inc.’s (Transcontinental or the Company) Issuer Rating at BBB, Senior Unsecured Debt rating at BBB, and Preferred Shares rating at Pfd-3; the trends remain Negative. The confirmation considers the declines in organic revenue and operating income over the past year, while acknowledging improvement in key credit metrics as a result of debt reduction. The trends remain Negative (as of April 20, 2012), based on 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. The ratings continue to be supported by Transcontinental’s leading market position, economies of scale, and healthy free cash flow generation, while also reflecting its deteriorating earnings profile, which is being structurally affected by a consumer shift toward digital forms of media.

Transcontinental has struggled to sustain organic revenues and profitability over the past year. Organic revenue declined by 2% due to the completion of the Canada census form contract in 2011, incentives granted to renew contracts, education reform in Québec, and a soft national advertising market. Total revenue increased by 6% in F2012 to $2.1 billion, primarily due to acquisitions, while operating income decreased by 2% to $358 million. Consolidated operating margins were down approximately 1.5% due to lower margins associated with the acquisition of Quad/Graphics Canada Inc. (Quad/Graphics Canada), print contract renewals, and increased competition in the media sector. Although operating cash flow was negatively affected by a number of one-time items, the Company was still able to generate $162 million of free cash flow. Transcontinental’s financial profile remained relatively stable in F2012, with the Company using free cash flow for capital investments and debt repayment. Gross debt-to-EBITDA decreased slightly to 1.37 times (x) for F2012 from 1.55x the prior year.

DBRS expects Transcontinental’s earnings profile to weaken over the longer term as the structural decline in demand for traditional print may outweigh the benefits of initiatives within the Company’s media sector. DBRS forecasts that consolidated revenues will be relatively flat to slightly higher in F2013, ranging between $2.1 billion and $2.2 billion. Print revenues are expected to remain flat at $1.5 billion as sales contributions from the Quad/Graphics Canada acquisition will likely be offset by the loss of the Company’s Zellers contract, as well as the renewal of contracts (which may prove to be positive long term as rates are expected to increase throughout the contract lives). It should be noted that the Company amended its contract with Hearst Corporation to print the San Francisco Chronicle. Transcontinental received a one-time payment of $200 million in return for annual price reductions of approximately US$30 million going forward. Media revenues may increase modestly from $712 million last year to between $725 million and $775 million in F2013 million as a result of acquisitions and the launch of new products. Margins are expected to decline slightly going forward, falling approximately 100 basis points from 16.9% in F2012 as a result of a shifting sales mix. As such, operating income is expected to remain relatively flat, ranging between $350 million and $360 million.

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 our concern regarding Transcontinental’s credit risk profile is not based primarily on the Company’s debt level, but rather on its future income and cash-generating prospects. 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 in key credit metrics over this period could result in a downgrade.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

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