DBRS Downgrades GFL Environmental Inc. to B; Trends Stable

DBRS Limited (DBRS) has today downgraded the Issuer Rating of GFL Environmental Inc. (GFL or the Company) to B from B (high). The trend remains Stable. Additionally, DBRS has confirmed the recovery rating of the Senior Unsecured Notes at RR4 but downgraded the associated instrument rating to B from B (high) to align the instrument rating with the RR4 recovery rating. The downgrade reflects a combination of a sharp increase in leverage and the resultant rise in financial risk, the lower than DBRS-expected operating results and a modestly weaker business risk profile.

The Company has announced that it is going to raise USD 250 million of senior unsecured debt and that it intends to use the net proceeds to repay all outstanding borrowings under its existing senior secured revolving credit facility; to repay all outstanding borrowings under, and retire, its senior unsecured term loan facility; and to fund a partial tender offer to purchase up to $50 million, in an aggregate principal amount, of its 7.5% senior unsecured notes due 2018. DBRS anticipates that some of the remaining cash from the new issuance will likely be used to fund growth investments, including acquisitions. Even though part of the proceeds from the new issuance will be used to repay existing debt, the net increase in debt will be substantial, materially raising the Company’s financial risk.

The Company has been in rapid growth mode in the last few years, mostly through debt-financed acquisitions. Additionally, GFL has had success in winning new municipal contracts; however, funding the resultant investments needed to support these new contracts has also added to debt. GFL has a highly leveraged balance sheet. Nevertheless, the Company has maintained its leverage as measured by the adjusted debt to run-rate EBITDA ratio (as defined by DBRS) of between 5.0 times (x) and 5.5x through 2014. Although aggressive, the leverage was acceptable to the B (high) rating. However, adding approximately another CAD 100 million in debt (USD 250 million net of repayments) will add to the Company’s already high debt burden. The elevated financial risk is no longer compatible with a B (high) rating. Even though the Company is likely to deploy the extra cash on growth initiatives (acquisitions or capital investments), it is uncertain that the incremental EBITDA (timing and amount) would keep the leverage to below 5.5x consistently.

The Company’s reported operating results in 2014 were below DBRS expectations as a result of higher than forecasted operating and selling and administrative costs. However, some of these higher costs, such as costs related to rebranding and acquisition, are likely to persist in view of the Company’s acquisition strategy. The increase in interest expense associated with the new debt has further reduced the margin for error, increasing the financial risk going forward. DBRS also notes that the Company’s recent acquisitions have also affected its business risk profile. GFL has meaningfully expanded its industrial and commercial business partly through acquisitions, and the revenue from municipal contracts has shrunk to less than 44% of its solid waste collection revenue in 2014 from 58% in 2013. The lower share from municipal contracts, which tend to be longer term in nature and less price sensitive, in the revenue mix is a modest negative to the business risk profile. Additionally, the pace of its acquisition activities as well as the size of recent acquisitions have also increased integration risk despite the Company’s good track record in assimilating acquired companies.

DBRS expects the current rating to remain Stable in the near term, supported by stronger operating results. Increasing contribution from recent acquisitions and contract wins should support ongoing revenue growth. DBRS expects operating profit to grow faster as margins recover absent the disruptive weather conditions experienced in 2014. Additionally, DBRS expects internal cash generation to be modestly positive despite an expected rebound in capital expenditures to support new contract wins. Furthermore, DBRS anticipates acquisitions to be at a comparable pace as in 2014 and for cash on hand and the available credit facility to be sufficient to finance the Company’s funding needs. However, DBRS has not factored in any material debt-financed acquisition in the near-term outlook, which would be treated as an event when announced.

Pursuant to its rating criteria on recovery ratings for non-investment grade corporate issuers, DBRS has created a default scenario for GFL in order to analyze when and under what circumstances a default could hypothetically occur and the potential recovery of the Company’s debt in the event of such default. DBRS has determined GFL’s estimated value at default by using an EBITDA multiple valuation approach, using a 4.0x multiple of normalized EBITDA. Based on the default scenario, the Senior Unsecured Notes would have a recovery estimated between 30% and 60%, which aligns with a recovery rating of RR4. Therefore, the instrument rating of the Senior Unsecured Notes is B, the same as the Issuer Rating.

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 for use in the European Union.

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