DBRS Places Armtec Holdings Limited Ratings Under Review with Negative Implications

DBRS has today placed the B Issuer Rating and B (low) Senior Unsecured Debt rating of Armtec Holdings Limited (Armtec or the Company) Under Review with Negative Implications, following an assessment of Armtec’s operating results in Q1 2014. The rating action reflects the heightened risk of covenant breach and liquidity tightness facing the Company as a result of operating losses and cash burn during the quarter resulting from severe weather conditions and continued challenging operating conditions. In addition, the increased borrowing under the secured revolving credit facility and the possibility of weaker enterprise valuation under the prevailing operating conditions could potentially combine to lower the recovery prospects (and therefore the recovery and instrument ratings) of the rated Senior Unsecured Debt.

Armtec reported negative EBITDA of $7.6 million and a reduction in credit availability and liquidity in Q1 2014, as sustained extreme cold weather conditions in much of Canada resulted in material delays in the Company’s project deliveries and affected the manufacturing process in its outdoor facilities. As a result of negative EBITDA and a higher debt level during the quarter, headroom under Armtec’s Brookfield Facility financial covenant (Senior Secured Debt-to-EBITDA required to exceed 5.25x) has been substantially reduced. DBRS estimates that, based on the current senior secured debt level, the Company will be required to generate EBITDA of about $8 million in Q2 2014 to ensure covenant compliance, and, in the event that the debt level increases further during Q2 2014, the required EBITDA could be higher. Although Q2 is seasonally a stronger quarter, Armtec indicated during its recent results announcement that the Q2 2014 results will be weaker than the corresponding Q2 2013 (when EBITDA of $15.1 million was recorded) because the severe weather extended into April 2014, operating conditions remain challenged by weak demand conditions in Eastern Canada and new entrants in Western Canada have led to increased competition and pricing pressure.

While Armtec expects improved year-over-year earnings in the second half of 2014 that are likely to partially offset the first-half shortfall, the Company could still potentially breach its financial covenants should Q2 2014 results fall short of expectations or if the second-half earnings do not improve as expected as a result of sustained weak demand conditions and competitive pressure. DBRS understands that Armtec is currently considering alternative financing solutions and will review such financing arrangements and their impact to Armtec when completed.

DBRS currently rates the Company’s Senior Unsecured Debt at B (low), one notch lower than Armtec’s Issuer Rating, to reflect a recovery rating of RR5 (10% to 30% expected recovery). The recovery analysis assumed a 4.0x multiple on a normalized EBITDA of about $38 million, full drawdown of the $110 million Brookfield Facility and drawdown of Secured Revolving Credit Facility between $20 million and $25 million. (See the DBRS Rating Report dated May 10, 2013, for details). With the last-12-month EBITDA for Q1 2014 at about $32 million and a possible further increase in secured revolver drawdown from the current $20 million level, the recovery rating on the Senior Unsecured Debt could potentially weaken further to RR6, which could result in a two-notch lower differential from Armtec’s Issuer Rating. (See “DBRS Methodology: Recovery Ratings for Non-Investment Grade Corporate Issues” for details.)

While the ratings are Under Review, DBRS will monitor and assess the covenant and liquidity situation in the next quarters, any alternative financing solutions or covenant relief that may be agreed upon, and the operating results for Q2 2014 and for the second half of the year. In the event that the Company’s liquidity situation becomes more acute or it fails to agree on an alternative financing solution that could alleviate concerns in covenant breach, the rating could be downgraded by one or more notches, depending on the severity of Armtec’s liquidity concerns. Materially weaker-than-expected operating results in any of the remaining quarters of 2014 could also result in an Issuer Rating downgrade. DBRS will also re-assess the recovery prospects of the Senior Unsecured Debt based on revised expectations in enterprise valuation and secured debt level. The instrument rating of the debt could also be downgraded in the event of a recovery rating downgrade to RR6 from RR5.

Conversely, to maintain the current ratings in the near term, Armtec will need to obtain a financing solution that will alleviate the current concerns over liquidity and covenant breach while not jeopardizing recovery prospects of the senior unsecured notes. In the longer term, improved earnings and cash flow resulting from more favourable operating conditions and progress in improving cost competitiveness or material debt reduction through equity injection could alleviate pressure on the ratings.

Notes:
All figures are in Canadian dollars unless otherwise noted.

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

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.

DBRS’s financial assessment is based on Armtec Infrastructure Inc. (AII), the listed Company that owns 100% of Armtec Holdings Limited (AHL), the issuers of the Senior Unsecured Debt. Apart from holding equity interest in AHL, AII has no other business operations.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.