DBRS Confirms Parkland Fuel at BB Following Agreement to Acquire Chevron’s Western Canadian Marketing Assets and Burnaby Refinery

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Senior Unsecured Notes rating of Parkland Fuel Corporation (Parkland or the Company) at BB with Stable trends. The recovery rating on Parkland’s Senior Unsecured Notes remains at RR4. The confirmation follows Parkland’s announcement that it has entered into an agreement with Chevron Canada Limited (Chevron) to acquire all shares of Chevron Canada R&M ULC, which operates its Canadian integrated downstream fuel business (the Acquisition). Parkland will pay approximately $1.46 billion plus an estimated $186 million in working capital for the acquired business.

Parkland intends to finance the Acquisition with a combination of debt, equity and other non-debt sources of cash (i.e., cash flow from operations) as follows:
-- Approximately $660 million of equity through a bought-deal private placement offering,
-- $258 million proceeds from a new commodity intermediation facility related to working capital at the Burnaby refinery,
-- $268 million drawn on an upsized revolving credit facility;
-- $500 million bridge credit facility (which DBRS expects will be replaced by senior unsecured notes prior to the close of the Acquisition); and
-- Approximately $40 million from other non-debt sources of cash, primarily including cash flow from operations.

As part of the Acquisition, Parkland is acquiring the following assets:
-- 129 Chevron-branded retail service stations principally located in the Greater Vancouver Area,
-- 37 commercial cardlock locations in British Columbia and Alberta,
-- Three marine fueling stations,
-- Chevron’s wholesale aviation business serving the Vancouver International Airport,
-- Three terminals located in Burnaby, Victoria, and Port Hardy, British Columbia, and
-- The Burnaby refinery, which is a 55,000 barrel per day refinery, processing mostly light sweet Western Canadian crude.

The Acquisition is expected to further increase Parkland’s scale by adding 2.5 billion litres of annual fuel volume from the acquired marketing business, increasing Parkland’s pro forma fuel volume to over 15.5 billion litres annually. DBRS believes that the Acquisition will also benefit Parkland’s geographic diversification, materially increasing the Company’s retail and wholesale presence in British Columbia. In addition, approximately 91% of the acquired retail services stations are on owned real estate. Parkland estimates the normalized EBITDA of the acquired business to be approximately $230 million. While DBRS recognizes the notable benefits of the Acquisition to Parkland’s overall business risk profile, DBRS also recognizes the higher volatility in the refinery business, driven by more volatile refining margins (relative to downstream margins) as well as planned and unplanned downtime and the associated costs of maintenance and repairs.

DBRS anticipates the EBITDA contribution from the Burnaby refinery to be well below levels considered to be normal in 2018 largely because of a major turnaround scheduled for Q1 2018. EBITDA will therefore be negatively affected by the planned downtime associated with the major turnaround effort as well as the significant cost of the turnaround, which is expected to be expensed rather than capitalized.

In terms of financial profile, the Acquisition will significantly increase Parkland’s balance-sheet debt by approximately $768 million to approximately $2.00 billion versus approximately $1.24 billion pro forma acquisition of CST Brands, Inc.’s (CST) Canadian assets, which is expected to close in Q2 2017. DBRS forecasts that Parkland’s lease-adjusted debt-to-EBITDAR will rise to well above 4.5 times (x) in 2018 because of the higher debt levels and lower earnings driven by the turnaround at the refinery. Key credit metrics should recover quickly thereafter to a level considered to be more than acceptable for the current BB rating (i.e., lease-adjusted debt-to-EBITDAR below 4.25x) as (1) earnings contribution from the refinery recover toward normal levels after the planned turnaround in Q1 2018 and (2) the Company begins to achieve planned synergies. If key credit metrics are weak for a longer period than anticipated because of weaker-than-expected operating performance or more aggressive-than-expected financial management (i.e., debt-financed acquisitions and/or increasing shareholder returns), the ratings could be pressured. Over the longer term, if Parkland (1) successfully integrates the acquisitions with solid operating performance (including the refinery operations) and (2) continues to reduce its reliance on the dividend reinvestment plan to fund the dividend while displaying sustainably strong credit metrics (i.e., lease-adjusted debt-to-EBITDAR below 3.75x, lease-adjusted EBITDA coverage above 4.5x and positive free cash flow after the gross dividend), a positive rating action could result.

DBRS believes that the appropriate leverage level for the current BB rating is now 4.25x versus previous statements at approximately 4.00x, reflecting the Company’s notable increase in size and scale as well as its improved geographic diversification since the rating was initiated. This is partially offset by the higher volatility associated with refinery earnings (i.e., volatility in refiner margins plus planned cost and downtime associated with turnarounds as well as the possibility of any unplanned downtime).

DBRS anticipates that Parkland’s free cash flow generation will improve after the Acquisition over the near to medium term, which will allow the Company to deleverage further by repaying amounts drawn on its revolving credit facility. DBRS believes that Parkland’s free cash flow before changes in working capital should increase to above the $175 million level by 2019 (including the Acquisition and Parkland’s prior-announced acquisition of CST, expected to close in Q2 2017) as the increased EBITDA is partially offset by higher dividends (because of an increase in the number of shares outstanding) and an increase in maintenance capex. Over the longer term, DBRS forecasts that free cash flow could rise above the $200 million level.

DBRS believes that the appropriate Issuer Rating for Parkland remains BB, despite modest weakening in the Company’s overall credit risk profile in the near term as the benefits to size, scale, geographic diversification and supply reliability are largely offset by further increases in balance-sheet debt, higher volatility in the refining business (versus the downstream business) as well as significant near-term integration and execution risks regarding the size of the Company’s two most recent acquisitions and its lack of experience in the refining business. DBRS does note Parkland’s plans to retain key management personnel with the knowledge and expertise operating the refinery which should help mitigate operational risks related to the refinery in the near term.

The recovery rating remains at RR4, albeit at the weaker end of the recovery range, considering increased indebtedness through new senior unsecured notes and an upsized secured revolving credit facility as well as stressed earnings generated, including from the new Acquisition assets. Should the limit on Parkland’s new upsized secured revolving credit facility be higher than DBRS expects, the recovery rating and therefore the rating on Parkland’s senior unsecured notes could be negatively affected.

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, geographic diversification across Canada and the sector’s relatively high barriers to entry. The ratings also reflect the industry’s competitive nature, exposure to economic cycles and volatility in refiner margins, 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 principal methodologies are Rating Companies in the Merchandising Industry and DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers, which can be found on dbrs.com under Methodologies.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.