DBRS Confirms Superior Plus LP at BB (high) with a Stable Trend

DBRS has today confirmed the Issuer Rating on Superior Plus LP (SP-LP or the Company) at BB (high) and the ratings of the Senior Secured Notes and Senior Unsecured Debentures issued by SP-LP at BB (high) and BB (low), respectively. All trends are Stable. Pursuant to DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers methodology, the recovery ratings of RR3 and RR6 on the above-noted securities are confirmed. SP-LP is a 99.9%-owned subsidiary of Superior Plus Corporation (SP-Corp), which is listed in the Toronto Stock Exchange. As SP-Corp has no other operating business, SP-LP’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.

SP-LP’s ratings reflect the leading market positions and steady cash flows from its Canadian propane distribution business in the Energy Services (ES) division and Specialty Chemicals (SC) production. The ratings also take into account SP-Corp’s deleveraging effort and the resulting improvement in financial metrics in the past two years and DBRS’s expectation that the improvement will continue until it reaches and maintains its internal leverage targets. These strengths were somewhat offset by a number of business challenges facing the Company. They include (1) limited near-term demand growth potential in both ES and Construction Product (CPD) division, (2) earnings exposure to various exogenous factors not within the Company’s control (such as winter temperatures and natural gas prices in ES, electricity costs in SC production) and (3) exposure of its sodium chlorate business to pulp mill production.

SP-LP’s business has been challenged since the recession in 2009 when performances of the companies it acquired to expand its geographic reach and customer base in the U.S. were below expectation, while demand for propane and heating oil were affected by unusually warm winters and demand for sodium chlorate in the SC division was affected by a decline in production in the pulp and paper industry. These headwinds, together with the significant debt burden used to finance the acquisitions, resulted in SP-Corp’s consolidated financial metrics being materially weaker than those expected for the Company’s ratings at the end of 2011.

Following the appointment of the new CEO, Mr. Luc Desjardin, in November 2011, and a subsequent strategic review of the businesses, SP-Corp has refocused its efforts on deleveraging its balance sheets and on a set of initiatives under its “Destination 2015” business plan aimed at reducing inefficiencies in business operations, improving customer focus to reduce attrition, exploring cross-selling opportunities and improving supply chain management to reduce working capital requirements. While the initiatives are a work in progress and are likely to generate tangible results over the next two to three years, the deleveraging efforts have been well under way. Through a reduction in credit facility drawdown, partial redemption of senior secured notes and convertible debentures since the end of 2011, SP-LP has reduced its total debt by $342 million as of March 31, 2013, and the reduction was funded through an equity issuance of $138 million in Q1 2013, operating cash flow and reduction in working capital during the period. As a result, SP-Corp’s financial metrics improved materially and are now consistent with those expected for the ratings, with adjusted cash flow-to-debt of 19% for last 12 months ended March 31, 2013, compared to 13% in 2011, and adjusted debt-to-EBITDA of 4.0 times (x) from 5.3x in 2011. Management has publicly stated its intention to continue deleveraging until SP-Corp reaches its target of lowering its unadjusted total debt-to-EBITDA to the low end of the 3.0x to 3.5x range (3.7x at March 31, 2013) and maintain that in the medium term.

SP-Corp’s liquidity remains acceptable for the ratings. It relies substantially on the $570 million credit facility ($339 million available as at March 31, 2013, and recently extended by one year to mature in June 2016) 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 further deleveraging as planned. DBRS recognizes that SP-Corp is currently objecting to a Notice of Reassessment of its 2009 and 2010 taxation years by Canada Revenue Agency (CRA) and intends to object similar reassessments for subsequent years expected to be received from CRA. While the issue remains unresolved, SP-Corp is required to pay CRA 50% of the contested tax amounts (estimated to add up to $26.5 million for taxable years between 2009 and 2013) upon receipt of reassessments expected between April 2013 and Q3 2013. The amounts are refundable in the event that the issue is resolved in SP-Corp’s favour. DBRS has not factored the financial impact of such payments to SP-LP’s ratings because of the uncertainty regarding the outcome and its timing.

SP-LP’s overall business risk profile remains 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. Although prices of the distributed products could fluctuate, the Company 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. Business volumes in the ES and SC divisions have been steady, albeit slow growing, in the long term, although short-term volume decline could occur in the event of warm winter temperature for ES and periods of low production in pulp industry affecting sodium chlorate demand. Electricity costs, which account for 70% to 85% of sodium chlorate variable production costs could also directly affect SC’s profit margin. Although normalized temperature in the past winter, recent improved pulp production and low electricity prices have been helpful to Superior’s results, these conditions are not within the Company’s control and there is no assurance that they will persist.

DBRS considers the business risk profile of the Company’s much 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. Despite recent improvement in U.S. housing starts, commercial and industrial sectors remain weak and the Canadian residential market is slowing down. As such, demand conditions remain uncertain and CPD’s future profitability will largely depend on its ability to improve its cost efficiency and supply chain management. DBRS believes that a material increase of the higher-risk CPD business, while currently not expected, could weaken Superior’s overall business risk profile and pressure the ratings.

The Stable trend on the ratings reflect DBRS’s view that, while the SP-Corp’s financial metrics have already improved to levels consistent with the rating, it will take a sustained management effort and more time before they return to levels supportive of a low-investment-grade financial risk profile. On the other hand, given management’s concrete deleveraging effort to date and its stated target, DBRS believes that the likelihood of deterioration in financial metrics and business risk profile that warrant a rating downgrade is now materially reduced. We also expect industry fundamentals, SP-LP’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 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 Industrial Products Industry (June 2013), which can be found on our website under Methodologies.