DBRS Confirms Parkland Fuel at BB Following Agreement to Acquire Majority of CST’s Canadian Assets

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Senior Unsecured Notes rating of Parkland Fuel Corporation (Parkland or the Company) at BB; the trends are Stable. The Recovery Rating on Parkland’s Senior Unsecured Notes remains at RR4. These confirmations follow the Company’s announcement that it has entered into an agreement with Alimentation Couche-Tard Inc. (Couche-Tard) to acquire the majority of the Canadian business and assets of CST Brands, Inc. (CST; the Acquisition) for approximately $965 million (an EBITDA multiple of approximately 8.5 times (x)). Parkland intends to finance the acquisition with a combination of debt and equity, including a $200 million bought deal private placement equity offering (with a 15% over-allotment option, which if exercised would reduce the amount drawn on the revolver), $545 million drawn on a new secured revolving credit facility (replacing Parkland’s existing revolver) and a $300 million bridge credit facility (to be replaced with alternative longer-term debt prior to the closing of the transaction).

Couche-Tard previously announced a definitive merger agreement with CST under which they will acquire CST, subject to customary conditions, including approval by CST shareholders and receipt of regulatory approvals. The Acquisition is conditional upon closing of the transaction between CST and Couche-Tard, among other conditions, including a Competition Bureau of Canada (Competition Bureau) review and is expected to be completed in early 2017.

Parkland is acquiring the following assets as part of the Acquisition:
-- Approximately 490 dealer and commissioned agent retail sites,
-- 72 commercial cardlock sites,
-- 27 commercial and home heating sites and
-- A substantial number of company-operated retail sites, representing a pre-determined proportion of EBITDA, to be determined following the Competition Bureau review of the Couche-Tard/CST transaction. (CST company-operated retail sites in Canada total approximately 300.)

The Acquisition will benefit Parkland’s scale, adding approximately 3 billion litres of fuel annually (excluding the CST company-operated retail sites referenced above) increasing sites to nearly 1,600 and pro forma fuel volumes to 13.3 billion litres. The Acquisition also adds annual adjusted EBITDA of $105 million to $115 million before synergies, a 44% increase over Parkland’s adjusted EBITDA for the last 12 months ended June 30, 2016. The Acquisition also adds significant benefit to Parkland’s geographic diversification adding a meaningful number of sites in Ontario, where the Company remained under-penetrated, as well as Québec and Eastern Canada, where the Company previously had no retail presence. The retail sites to be acquired by Parkland operate under the Ultramar brand, which is considered to be a strong brand, particularly in Québec and Eastern Canada. On the supply side, the Acquisition will further strengthen Parkland’s position as a customer of Valero Energy Corp. who is the primary fuel supplier for the sites being acquired and with whom Parkland previously had an existing relationship, which could possibly present synergy opportunities. Overall, DBRS views the impact of the Acquisition as a moderate positive to the Company’s business risk profile.

In terms of financial profile, the Acquisition will significantly increase Parkland’s balance sheet debt by $815 million to $845 million (depending on the exercise of the over-allotment option on the Company’s share issuance) to approximately $1.24 billion to $1.27 billion. On a pro forma basis, DBRS estimates Parkland’s lease-adjusted debt-to-EBITDAR after the Acquisition will rise to between the 4.20x and 4.30x range (and lease-adjusted EBITDA coverage of approximately 4.5x), beyond the level previously considered acceptable for the current BB Issuer Rating. On the Company’s conference call detailing the Acquisition on August 22, 2016, it stated that it intends to reduce leverage from its estimated pro forma total funded debt-to-EBITDA of approximately 3.5x at the close of the transaction to under 3.0x within 12 months to 18 months. Such deleveraging is expected to return key credit metrics to a level considered adequate for the current BB Issuer Rating (i.e., lease-adjusted debt-to-EBITDAR below 4.0x) within an acceptable timeframe. DBRS believes the Company will have the ability to deleverage based on a combination of earnings growth, including expected synergies (in the $15 million to $20 million range), and/or the repayment of amounts drawn on the credit facility with free cash flow. DBRS believes Parkland’s free cash flow before changes in working capital should increase above the $50 million level in the first year after the Acquisition as the increase in earnings is partially offset by a significant increase in the cash dividend and maintenance capital expenditure (capex; approximately $20 million attributable to the acquired assets). Free cash flow should continue to rise toward the $100 million level thereafter, primarily with growth in organic operating income and the achievement of synergies as dividends and capex remain relatively stable.

DBRS believes the appropriate Issuer Rating for Parkland remains BB as the modest negative on the Company’s overall credit risk profile from the material increase in balance sheet debt and the risks related to the integration of the acquired assets is mitigated by the improvement to Parkland’s business risk profile, its commitment to reduce leverage in a timely manner and management’s solid historical track record of meeting commitments.

Parkland remains acquisitive in nature; as such, DBRS expects that any future acquisitions within the deleveraging time frame will be financed in a manner that will not prevent the Company from returning key metrics to the range considered acceptable for the current BB rating. However, should Parkland be challenged to improve credit metrics to a range considered acceptable for the BB Issuer Rating within 12 months to 18 months, due to weaker-than-expected operating performance or more aggressive-than-expected financial management, the current ratings could be pressured.

The Recovery Rating remains at RR4, albeit at the weaker end of the recovery range after considering the likelihood of increased indebtedness through the use of the Company’s new revolving credit facility and the stressed earnings generated, including from the newly acquired assets.

Parkland’s ratings continue to be driven by its strong position as Canada’s largest independent marketer and distributor of fuel, its efficient operations, diversified customer and supplier base, improving geographic diversification and relatively high barriers to entry. The ratings also reflect the competitive nature of the industry, exposure to economic cycles, particularly in the commercial business, risks associated with environmental liability and risks associated with growth primarily through acquisitions.

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: Recovery Ratings for Non-Investment Grade Corporate Issuers, which can be found on our website under Methodologies.