DBRS Downgrades Transcontinental to BBB (low), Pfd-3 (low), Stable Trends

DBRS has today downgraded the Issuer Rating and Senior Unsecured Debt rating of Transcontinental Inc. (Transcontinental or the Company) to BBB (low) from BBB and its Preferred Shares rating to Pfd-3 (low) from Pfd-3. The trends are now Stable.

The downgrade reflects continued pressure on the Company’s organic revenues and profitability as a result of a consumer shift away from traditional print media, despite reduced financial leverage. The revised ratings consider that weakening demand for print advertising will likely continue to have a negative impact on the industry and the Company’s revenues, margins and cash flow generating capacity over the longer term. The Stable trends reflect DBRS’s view that Transcontinental will be able to absorb the structural forces within the revised rating category over the near-to-medium term, due in large part to its modest financial leverage and free cash flow generation. The ratings continue to be supported by the Company’s leading market position and economies of scale in its core businesses.

In F2013, Transcontinental’s organic revenue declined by 4.2% due to a modest decrease in the demand for print products across the board, a soft advertising market and the loss of the Zellers printing contact. However, total revenue was relatively flat at $2.1 billion due to the acquisition of Quad/Graphics Canada, along with smaller tuck-in purchases within the Media sector. Consolidated EBITDA margins eroded slightly due to lower revenues in the higher-margin publishing operations within the Media segment and development spending associated with digital products. As a result, EBITDA decreased modestly to $349 million from $358 million last year.

In terms of financial profile, cash flow from operations increased to $328 million from $274 million in F2012 due to a decrease in spending related to restructuring initiatives and a decrease in cash taxes from exceptionally high levels in F2012. The Company used a combination of free cash flow and the USD 200 million upfront payment received from the renegotiation with Hearst Corporation, to pay out a special dividend of $78 million in March 2013 (over and above their regular dividend of $53 million for the year). Transcontinental directed the majority of its remaining cash flow toward $147 million of debt repayment. As a result, gross debt-to-EBITDA decreased to 1.0 times from 1.4 times the prior year.

DBRS expects Transcontinental’s earnings profile to weaken over the longer term as the structural decline in the demand for traditional print subscriptions and advertising may outweigh cost containment efforts and the potential benefits of new strategic initiatives. DBRS forecasts that revenues will remain relatively flat in F2014, ranging between $2 billion and $2.1 billion. Print revenues may erode modestly due to lower volumes in magazine and book printing contracts, while media revenues are expected to increase slightly as a result of acquisitions completed in F2013. If approved, DBRS notes that the Company’s recent deal to acquire all of Sun Media’s newspapers in Québec will result in $75 million to $80 million of incremental revenue annually (and approximately $20 million of incremental EBITDA). EBTIDA margins are expected to remain stable in F2014 as cost containment efforts and lower digital expenses are expected to offset declines in the print business. As such, DBRS expects EBITDA to range between $340 and $360 million in F2014.

Going forward, DBRS expects Transcontinental will use its free cash flow for acquisitions and/or debt repayment. DBRS’s 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. DBRS notes that Transcontinental has begun to diversify its sources of revenue and DBRS believes the Company will continue to search for growth opportunities going forward. Although Transcontinental’s revised ratings allow it significant room to manoeuvre and execute on a diversification strategy over the near to medium term, a faster than expected decline in organic revenue and operating income and/or a meaningful deterioration in key credit metrics could result in pressure on the ratings.

Notes:
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 for use in the European Union

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