DBRS Upgrades RTL-Westcan Limited Partnership’s Issuer Rating to BB (low), Stable Trends

DBRS has today upgraded the Issuer Rating of RTL-Westcan Limited Partnership (RTL or the Partnership) to BB (low) from B (high) and confirmed the BB (low) instrument rating, with a recovery rating of RR3, on the Partnership’s Senior Secured (Second Lien) Debt. The trend for all ratings is Stable. The upgrade of the Issuer Rating largely reflects RTL’s significantly improved financial risk profile following its deleveraging effort in the past two years, causing its financial metrics to be strong, even for the revised rating level, and continued market leadership in the niche hauling market for fuel and bulk products in western and northern Canada. The challenges of operating in a competitive market and being exposed to factors not within the Partnership’s control, such as driver availability and weather-related disruptions, constrain RTL’s business risk profile and further upside on the ratings. In accordance with the “DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers” criteria (revised in January 2013), the instrument rating remains unchanged at BB (low) as the rating of a debt instrument with a RR3 recovery rating issued by a BB-range issuer will now be the same as the Issuer Rating.

In the last rating report dated February 27, 2012, DBRS recognized RTL’s improving operating performance, application of improved cash flow toward debt reduction and stronger financial metrics in fiscal 2011 (year ending October 31, 2011). At that time, however, DBRS also believed that the Partnership’s debt coverage metrics in fiscal 2012 would remain at similar levels and expected operating cash flow to be used to finance a high level of capex as the fleet renewal and expansion program continued. Instead, RTL was able to reduce its debt level further by approximately $23 million, made possible by cash proceeds from the sale of its aviation division in August 2012 and moderately lower capex and working capital requirements during the year. On aggregate, RTL has reduced its debt level by more than $40 million since it issued the senior secured notes in fiscal 2010. As a result, the Partnership’s debt coverage metrics further improved, with adjusted cash flow-to-debt of 23% in fiscal 2012 compared to 9% in fiscal 2010 and debt-to-EBTIDA at 3.2 times (x) from 5.0x during the same period. DBRS understands that RTL intends to maintain its financial metrics at similar or moderately better levels in the medium term. Although these financial metrics are considered strong for a BB-rated issuer, DBRS believes that they are necessary for RTL to maintain its current ratings because of the challenges facing the Partnership’s operations, as discussed above.

RTL continues to be a market leader in the niche segment of providing hauling services for fuel and bulk products (including grain, fertilizer, anhydrous ammonia, sulphur, lime, salt, coal and asphalt), with a focus on the western and northern Canadian markets. With one of the largest fleets in the region and good supporting facilities, the Partnership has a strong market position, ranking among the top three players and capturing at least 30% market share in each product segment. Although the trucking industry is fragmented, there is a material barrier of entry in RTL’s specific niche segment, created by the need to invest in and efficiently manage a specialized fleet, as well as safety requirements for hauling hazardous or inflammable goods and the capability required to handle transport in harsh weather conditions. This, in combination with the Partnership’s ownership of a network of supporting facilities (warehouses, yards and fuel tanks), should help make RTL’s market position defendable and limit future competition. The recent acquisition of Saskatchewan-based Wrangler Tank Services Ltd. (WTS) could potentially help cement RTL’s competitive position in the oil and gas upstream market.

Following the disposal of the aviation division to Ledcor Air Limited (Ledcor Air) in August 2012, hauling is essentially the dominant business of the Partnership, generating more than 90% of revenue and EBITDA. Its construction division carries a supportive role to hauling, with its equipment utilized to construct winter roads for hauling to remote and frigid northern Canada, while engaging also in civil construction projects for mining and infrastructure activities to maximize capacity utilization.

DBRS considers the trucking industry highly cyclical and, as a relatively small niche player serving specific industry segments in a focused geographic region, RTL is exposed to specific factors that could affect its revenue and earnings. Demand for its hauling services could be affected by production volume and prices of fuel and other bulk commodities, weather conditions affecting agricultural and road construction activities, as well as demand for heating fuel and winter road transports. In addition, while industry competition keeps pricing competitive, hauling operators have limited control over a number of cost items such as fuel and labour. This was evident in fiscal 2009 and 2010 when a combination of factors (weak economic conditions, unfavourable weather patterns, driver shortages and increased maintenance costs) resulted in EBITDA that was 25% to 30% lower than the level seen in fiscal 2008.

DBRS understands that RTL has taken measures to reduce revenue and earnings volatility by (1) supplementing its year-round baseload fuel hauling business with other products that have different seasonal peaks, (2) completing a fleet renewal program with purchases of newer and more fuel-efficient tractors and (3) focusing on hiring and training new drivers to alleviate driver shortages. The efforts have shown some results as the EBITDA (before a management fee) margin of the hauling division improved to 19.1% in fiscal 2012 from 17.5% in the preceding year. However, DBRS believes that these efforts could only partly reduce the impact on earnings if conditions in fiscal 2010 were to repeat themselves, and would not entirely mitigate the inherent volatility of the industry.

Despite the industry risks mentioned above, RTL has a proven track record of performance and safety, which allows it to maintain long-established business relationships with mining and oil and gas operators in the region and enter into medium-term contracts (typically with three to five years of duration) with these clients. DBRS understands that more than three-quarters of the Partnership’s revenue is generated by these contracts. These relationships provide a degree of earnings and cash flow stability, and the Partnership has been able to generate approximately $10 million to $20 million in free cash flow annually under normal business conditions, which was applied toward debt reduction in the past two years.

The ratings and Stable trend reflect DBRS’s expectation that RTL’s more modern and fuel-efficient tractor fleet and the expanded business through the acquisition of WTS should support the Partnership’s leading position in the hauling market in western and northern Canada. With the deleveraging effort in the past two years, RTL’s financial metrics are now strong for the rating, although DBRS considers this necessary to cushion against volatility and challenges inherent in RTL’s business, which often are beyond its control, as was the case in fiscal 2010. RTL’s ratings could be pressured in the event of a prolonged period of weak hauling volume and competitive pressure, or a material deterioration of the Partnership’s market position. A materially debt-financed acquisition, which may result in materially weaker debt coverage metrics, with adjusted cash flow-to-debt falling below 20% and adjusted debt-to-EBITDA exceeding 3.5x on a sustained basis, could also result in lower ratings. RTL’s current modest business scope, scale and geographic reach in a relatively volatile hauling market will remain a significant constraint to any further rating upgrade. In the longer term, RTL will need to materially improve its business scope and stability while maintaining its financial metrics at or improving them from their current levels for a further rating upgrade to be considered.

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 methodology is Rating Companies in the North American Trucking Industry, which can be found on our website under Methodologies.