DBRS Assigns Wajax Ratings at BB (high) with Stable Trend

DBRS has assigned an Issuer Rating of BB (high) to Wajax Corporation (Wajax or the Company), along with a rating of BB (low) to the Company’s Senior Unsecured Notes based on a recovery rating of RR6, both with Stable trends. DBRS has determined the Issuer Rating using the DBRS methodology “Rating Companies in the Capital Goods Dealership Industry,” while the Senior Unsecured Notes rating has been determined using DBRS methodology “Recovery Ratings for Non-Investment Grade Corporate Issuers”. The ratings reflect the Company’s business profile which is weaker than the assigned industry risk profile of BBB, as well as a forward looking and historical assessment of its relatively stronger financial profile.

Wajax is a distributor of capital goods with a large branch network across Western Canada, Ontario and Eastern Canada and is engaged in the sale and support of mobile equipment, power systems and industrial components. The Company has grown historically through acquisitions but also in-line with economic growth as well as due to expansion of the country’s natural resource sector over the last decade. The Company’s business profile is mainly supported by the scale of Wajax operations, which conducts business through three business segments, with each having an extensive network across the country, making it the largest multi-line distributor in Canada. Additionally, the Company has a large and growing product support revenue base which adds stability through the economic cycles. The Company benefits from its broad exposure, including geographic and end-market diversification. As a result, revenues are generally more stable and grew at a 3.9% compound average growth rate from 2012 to 2008, while EBITDA grew at 4% over the same period, with the Company exhibiting less volatility relative to the cyclical capital goods industry.

Constraining the business profile is Wajax’s multi-OEM (original equipment manufacturer) model in the mobile equipment segment. While Wajax has a diversified exposure to various manufacturers, the Company’s reliance on a mix of OEM relationships could be disadvantageous relative to those dealers who deal with a single leading OEM. Those dealers are able to fully align themselves and benefit from the OEM’s leading brand, market position and competitiveness. To this end, Wajax has been able to achieve a smaller market share than the other two publically traded dealers. Furthermore dealing with multiple OEMs can be challenging because each can demand investment in minimum inventory, resulting in several OEM-specific inventories. Lastly, Wajax faces the risk of losing a distribution agreement due to an acquisition of one of its smaller OEMs by a competitor, similar to the acquisition of LeTourneau Inc. by Joy Global.

The Company’s large and growing product support revenues add a degree of stability through the economic cycles. However, most of the Company’s product support revenues consist of parts sales in the industrial components division, which are quite stable but not as profitable and therefore this segment has lower operating earnings profitability of about 6%. Consequently, the Company also has a lower operating earnings margin relative the industry. Although DBRS acknowledges that the equipment and power systems segments have a 7% to 8% operating earnings margin, the overall Company profitability averaged approximately 6% over the preceding five years, in contrast to approximately 7% to 10% for larger dealers.

The Company’s financial metrics have deteriorated recently from historical levels. Most metrics at last twelve months (LTM) June 30, 2013, exceed the currently assigned ratings, however, the financial profile has turned more aggressive, also noting that the Company maintains an aggressive dividend policy of paying out approximately 75% of earnings. Some comfort is derived from the fact that distributions are limited by the Company’s credit agreement in the event that leverage exceeds 3 times (x). Nonetheless, leverage has been rising, from the beginning of 2012 up until June 30, 2013, and the Company incurred additional indebtedness of approximately $150 million due to aggressive investment in inventory, as well as due to cash tax payments associated with Wajax’s conversion from an income trust. As such, DBRS calculated debt-to-EBITDA has risen from 0.7x at the end of 2011 to 2.2x for LTM at June 30, 2013, and DBRS expects this level of leverage to persist going forward.

The Company has also historically grown through acquisitions, and therefore has a high balance of intangible assets on the balance sheet, making the equity base more susceptible than otherwise to a write down. This, combined with higher leverage and a high dividend payout, limit the financial flexibility of the Company and represent an ongoing risk. At the same time, DBRS has factored into its rating the working capital and the less-capital-intensive nature of operations, both of which partially offset the negative features of the financial profile and add flexibility. The working capital orientation of the business, and the resulting decreased need for inventory and receivables, provide a source of cash to reduce debt during downturns. Indeed, in the 2009 period, Wajax was able to use the proceeds from working capital to reduce debt.

DBRS expects the current resource sector slowdown to impact Wajax’s revenues, earnings and cashflows negatively over the next six to twelve months, although Wajax’s exposure to less cyclical sectors, such as material handling, construction and government, should serve to offset some of the declines. DBRS expects that net free cash flow will remain negative for the full year 2013 due to high working capital investments, as well as investment relating to rental assets and capex. Despite this, DBRS expects that the financial profile will be in-line with the current rating over 2013, barring significant downturns in the capital goods industry, and that Wajax will continue to benefit from its broad distribution network and favourable revenue composition. DBRS expects the Issuer Rating to remain at BB (high), although a review will occur in the case that the Company’s indebtedness increases significantly or in the event of a more severe economic contraction. Pursuant to our rating methodology “DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers,” DBRS has determined Wajax’s asset value at default based on a liquidation analysis, in which DBRS applies discount values to Wajax’s assets. The recovery prospects for unsecured debt holders are poor, which corresponds to a RR6 rating (0% to 10% expected recovery). (See the Recovery Analysis section in the Rating Report for more detail.)

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.

This rating is endorsed by DBRS Ratings Limited in the European Union.

The applicable methodology is Rating Companies in the Capital Goods Dealership Industry, which can be found on our website under Methodologies.