DBRS Assigns Issuer Rating of BB to Parkland Fuel Corporation

DBRS has today assigned an Issuer Rating of BB to Parkland Fuel Corporations (Parkland or the Company) and a provisional rating of BB, with a recovery rating of RR4, to Parkland’s proposed issuance of Senior Unsecured Notes, both with Stable trends.

Parkland’s ratings reflect the high level of competition in and the commoditized nature of the greatly fragmented fuel distribution industry; the industry’s exposure to macroeconomic factors, such as economic growth and input cost volatility; and risks related to environmental liability and the Company’s ambitious growth plans. The Company’s ratings are supported by its market position as the largest independent fuel distributor and marketer in Canada, its efficient operations and its diversified customer and supplier base.

Parkland’s recent history of strategic acquisitions, combined with its value proposition, which consists of retail locations in primarily non-urban less-competitive areas, and high reliability of fuel supplies for its commercial customers, has enabled the Company to grow its fuel volumes from just over 2 billion litres in 2008 to approximately 7.5 billion litres for the last 12 months (LTM) ended Q1 2014. Top-line sales have correspondingly increased to nearly $6.5 billion (for the LTM ended Q1 2014) from approximately $2.3 billion in 2008. Gross profit (on a cents-per-litre basis) has remained relatively stable over the longer term despite the volatility in fuel prices and refiners’ margins, while Parkland has been relatively successful in managing organic selling, general and administrative expenses as the Company has grown. As such, EBITDA has grown consistently, increasing from approximately $81.2 million in 2008 (including the effects of refiners’ margins) to current levels of normalized EBITDA estimated by DBRS at approximately $180 million for the LTM ended Q1 2014.

Parkland’s financial profile is considered adequate for the current rating category based on its cash-generating capacity, and DBRS’s expectation that Parkland’s leverage will increase toward its stated target levels (i.e., net debt-to-EBITDA of 2.0 times (x) to 3.0x). Cash flow from operations has grown to approximately $155 million for the LTM ended Q1 2014, while maintenance capital expenditure (capex) requirements have remained relatively modest despite the number of acquisitions completed in recent years (increasing to nearly $25 million in 2013 from approximately $7 million in 2009) and the Company’s continued investment in growth capex (approximately $30 million for 2013). Parkland’s gross dividend is considered to be high (approximately $73 million for 2013) but the cash outlay related to dividends remains reasonable (approximately $23 million) due to a consistent and high participation rate of nearly 70% in the Company’s dividend reinvestment plan (DRIP). As a result, free cash flow before changes in working capital (net of non-cash dividends from participating in the DRIP program) has increased in each of the last four years from negative to approximately $76 million for the LTM ended Q1 2014. Parkland’s balance sheet debt at Q1 2014 was approximately $342 million (excluding approximately $129 million of convertible debentures) resulting in lease-adjusted debt-to-EBITDAR of approximately 2.0x (or 2.4x using a DBRS estimate for normalized EBITDA).

DBRS expects that Parkland’s earnings profile should improve steadily over the medium term as the Company remains focused on growth, primarily through acquisition, with the goal of increasing its market share and fuel volumes. Organic fuel volumes and gross margins on a cents-per-litre basis should remain relatively stable over the longer term (particularly within each operating segment, i.e., commercial versus retail versus wholesale), while the Company is expected to continue to focus on improving efficiency and achieving synergies subsequent to numerous recent acquisitions. As such, DBRS forecasts that EBITDA should continue to grow in the low- to mid-single digit range in the medium term, while, with acquisitions, EBITDA could grow to over $250 million. In order for Parkland to achieve its stated goals for EBITDA (approximately $250 million) by 2016, DBRS believes that the Company will have to undertake numerous and/or large acquisitions, which is not without integration and valuation risk.

In terms of financial profile, the Company is expected to issue $150 million of Senior Unsecured Notes in conjunction with a voluntary $100 million reduction to the maximum amount available under its current revolving credit facility. The proceeds from the Senior Unsecured Notes are expected to be used to repay amounts drawn on the existing revolver and, as such, credit metrics immediately after the new issuance are not expected to change materially.

Going forward, DBRS expects that Parkland’s leverage will increase toward the Company’s stated target levels (i.e., net debt-to-EBITDA of 2.0x to 3.0x). Parkland’s cash flow from operations should grow in line with operating income, while maintenance capex is expected to grow with the size of the Company. Gross dividends are expected to remain high, but the cash outlay related to dividends should remain reasonable. DBRS believes Parkland’s growth plans will be financed using free cash flow, incremental debt and possibly equity. Should Parkland be challenged to maintain credit metrics in a range considered acceptable for the current BB rating category (i.e., lease-adjusted debt-to-EBITDAR less than 4.0x and/or lease-adjusted EBITDA-to-interest greater than 4.0x) due to weaker-than-expected operating performance and/or more aggressive-than-expected financial management (debt-financed acquisitions and/or higher-than-expected cash dividends from rising dividends or declining participation in the Company’s DRIP), the Company’s current rating could be pressured. Alternatively, should the Company be successful in improving its scale and geographic diversification, reaching normalized EBITDA of greater than $250 million while maintaining current leverage targets and sustainable lease-adjusted debt-to-EBITDAR below 3.5x, a positive rating action could result.

RECOVERY ANALYSIS
DBRS concluded after its review, it was likely that holders of Parkland’s proposed Senior Unsecured Notes would recover between 30% to 60%, representing a recovery rating of RR4.

PROPOSED SENIOR UNSECURED NOTES
Parkland is expected to issue $150 million of Senior Unsecured Notes (the Notes):
-- The Notes are expected to mature in 2021.
-- Proceeds of the notes will be used to repay amounts drawn on the Company’s credit facility, and for general corporate purposes, including, without limitation to fund Parkland’s working capital requirements and potential future acquisitions.
-- The Notes will be direct senior unsecured obligations of Parkland and will rank pari passu with all of Parkland’s existing and future senior indebtedness and senior in right of payment to any future subordinated indebtedness and the Company’s currently outstanding convertible debentures.
-- The Notes will be effectively subordinated to all secured indebtedness, including Parkland’s current credit facility.
-- Terms of the notes are expected to include several customary high-yield provisions including:
(1) Optional redemption,
(2) Equity claw-back,
(3) Change of control and
(4) Covenants limiting Parkland’s ability to:
-- Incur additional debt,
-- Make certain restricted payments and investments,
-- Create liens,
-- Enter into transactions with affiliates,
-- Consolidate, merge or transfer all or substantially all of its property and assets and
-- Transfer and sell assets.

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 methodologies are Rating Companies in the Merchandising Industry and DBRS Criteria: DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers, which can be found on our website under Methodologies.

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