DBRS Confirms Finning International at A (low), Stable Trends

DBRS has today confirmed the Issuer Rating and the Senior Debentures and Medium-Term Notes rating of Finning International Inc. (Finning or the Company) at A (low), and the Company’s Commercial Paper rating at R-1 (low), all with Stable trends. The confirmation primarily reflects Finning’s superior business profile, although its financial profile presently remains weak for the A (low) rating category. Finning is Caterpillar’s (CAT; rated “A” and R-1 (low), Stable) largest dealer, also benefiting from sizeable and steady product support revenues, as well as favourable geographical exposure.

Finning’s financial profile showed improvement over 2013, after it weakened due to the fully debt-funded acquisition of Bucyrus International Inc. (Bucyrus) in 2012. Adjusted gross debt-to-EBITDA improved to 2.57 times (x) and cash flow-to-debt improved to 0.33x on a trailing 12-month basis as at September 30, 2013, relative to 2.83 and 0.29x, respectively, for LTM at the same time last year. DBRS recognizes that the current financial profile still remains weak for the rating, however, the Stable trends also incorporate our view that adjusted debt-to-EBITDA will continue to improve for full year 2013 and over 2014 as Finning applies net free cash flow to debt reduction.

The Company performed as expected during the first three quarters of 2013, achieving low single- digit revenue growth and higher EBIT margins compared to the first three quarters of 2012. New equipment sales were down by approximately 7% mostly due to the mining industry’s significant pull-back on capital expenditures but product support revenue has nonetheless remained resilient increasing by approximately 13%. Canada and the United Kingdom were the worst performing regions led by mining-related equipment sales declines, although product support revenues saw positive growth in both segments. Finning’s South American segment performed strongly, increasing revenues by 11% with product support up by 17%. The Company’s results continued to reflect the integration of Bucyrus and also benefited from the progress towards resolution of the enterprise resource planning issues, which had dragged results and impacted customer relationships for the last few years in the Canadian segment.

Over the course of 2013, Finning continued the integration of the Bucyrus mining distribution units, although it faced some challenges particularly in the parts and service franchise in South America as well as in the delivery of shovels in Canada. While management believes that integration has largely been complete in the Canadian segment, the resolution of these challenges will continue to be the focus over 2014 in the South American segment. The addition of Bucyrus should enhance Finning’s business profile over the long term, due to an increased product diversity mix, expansion of sales territories and the introduction of product bundling, although it would not be unexpected for the benefits to take some time to be fully realized.

Finning’s business profile is otherwise expected to remain stable, with strong territorial coverage and a good business mix with a substantial percentage of revenues derived from the stable and higher-margin product support activities. Finning continues to be a market leader with solid market shares in its territories, although management has recently pointed out some incremental market share declines which it intends to recapture. Finning continues to benefit from its relationship with its original equipment manufacturer CAT.

DBRS believes that the revenue outlook for 2014 is relatively softer and expects that sales will likely stay flat or decline in the low single-digit range, largely due to Finning’s exposure to mining related products in Canada and Chile. New equipment sales in power systems, construction and forestry industries could serve to provide some protection to declines resulting from mining-related sales in Canada, as is product support, which should continue to remain robust due to fundamentals such as a growing equipment population base and greater customer equipment utilization. The Company’s commitment relating to operational initiatives, expansion of higher-margin revenue sources and the ongoing shift towards product support revenues should help support EBIT margins in 2014.

From a credit point of view, however, DBRS expects for the financial profile to improve in the near-term. While cash flow from operations is not expected to increase substantially in 2014 due to a slower environment, DBRS anticipates that a number of factors will contribute to higher net free cash flows which will allow for some room for debt reduction. Reductions in working capital due to slowing new equipment sales, Finning’s focus on reducing invested capital and reduced capital expenditures should allow Finning to generate excess net free cash flow for full year 2013 and over 2014 to reduce debt. DBRS notes these efforts are consistent with historical experience when elevated leverage was brought down to target.

DBRS expects that the Company’s solid business profile will continue to support the rating, although the financial profile remains weak considering the presently elevated leverage. DBRS expects Finning to show a trend of continuous decrease in leverage over 2014 and reiterates that failure to attain a trend of such improvement could result in negative rating action.

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