DBRS Confirms Saputo Inc. at A (low) Following Acquisition of Murray Goulburn Co-Operative Co. Limited

DBRS Limited (DBRS) confirmed the Issuer Rating and Senior Unsecured Notes rating of Saputo Inc. (Saputo or the Company) at A (low) with Stable trends following the Company’s announcement that it had entered into an agreement (the Acquisition) to acquire the business of Murray Goulburn Co-Operative Co. Limited (Murray Goulburn). The total value of the Acquisition is $1.29 billion (AUD 1.31 billion) on a debt-free basis and is expected to be financed through a newly committed bank loan. The Acquisition is subject to regulatory and shareholder approval and is expected to close in the first half of calendar year 2018.

Murray Goulburn is one of the largest processors, manufacturers and distributors of dairy products, including drinking milk, milk powder, cheese, butter and infant formula, in Australia. It also supplies retail and food service companies globally through its brands Devondale, Liddells and Murray Goulburn Ingredients. Murray Goulburn operates 11 manufacturing facilities in Australia and China. In F2017 (ended June 30, 2017), Murray Goulburn generated revenue of nearly AUD 2.5 billion and EBITDA of AUD 78 million. Because of a difficult operating environment and internal operating challenges, this is a significant decrease from its five-year annual average of AUD 2.7 billion in revenue and AUD 130 million in EBITDA.

Saputo’s revenue grew to $11.4 billion in the last 12 months (LTM) ended Q1 F2018 from $11.0 billion in F2016. The increase was primarily attributable to higher pricing and a favourable product mix in Canada and volume growth in the United States. EBITDA margins improved to 12.3% in the LTM ended Q1 F2018 versus 10.7% in F2016 based mainly on efficiency improvements and operating leverage, partially offset by higher administrative expenses related to the Company’s SAP implementation. As a result, Saputo’s EBITDA increased to $1.3 billion in the LTM ended Q1 F2018 from $1.2 billion in F2016.

The Acquisition will strengthen Saputo’s market position, size and diversification in the Australian dairy market and complement the Company’s existing Dairy Division. The Acquisition will increase the Company’s market share in Australia to roughly 33% from approximately 10%. The Australian market has very little dairy regulation, as there are no quantity limitations imposed on milk produced, processed or sold, and there is no legislative control on milk prices. As Australia exports approximately 40% of the milk it produces, the Acquisition will give Saputo further access to growth in international markets. Pro forma the Acquisition, DBRS expects credit metrics to weaken (lease-adjusted debt-to-EBITDAR increasing to nearly 2.1 times (x) from 1.3x and lease-adjusted EBITDAR coverage declining to around 19.0x from 30.7x) to the low end of the current rating category. DBRS believes these metrics will improve going forward, as the Company will likely use free cash flow toward debt reduction.

Going forward, without a meaningful contribution from Murray Goulburn, DBRS believes Saputo’s revenue will grow in the low single-digit range in F2018, based on population-driven consumption in Canada and the United States and domestic and export volume growth in the International sector. DBRS believes EBITDA margins will continue to improve in F2018, benefiting from favourable market conditions in the International sector, ongoing efficiency improvements and operating leverage. As a result, DBRS anticipates that EBITDA will grow to more than $1.35 billion in F2018. DBRS notes that the Comprehensive Economic and Trade Agreement, which came into effect September 21, 2017, will allow an additional 17,000 tonnes of European cheese to be exported to the Canadian market, raising the total import quota from the European Union on cheese to 30,000 tonnes. Large manufacturers, including Saputo, will be allocated approximately 20% of the quota. DBRS believes that the agreement will not have a material impact on Saputo’s earnings profile, as the additional allotment of European cheese will be primarily focused on specialty cheeses and is small relative to the size of the overall market.

In terms of financial profile, DBRS anticipates that free cash flow after dividends and before changes in working capital will remain strong at more than $550 million in F2018 as cash flow from operations increases in line with operating income, capital expenditures grow because of the Company’s SAP implementation and efficiency improvements, and the target dividend payout ratio remains at approximately 30%. DBRS expects that Saputo will continue to allocate its free cash flow toward debt reduction and acquisitions such that net debt-to-EBITDA remains below the Company’s long-term target of 2.0x (equivalent to lease-adjusted debt-to-EBITDAR of approximately 2.2x). Should lease-adjusted debt-to-EBITDAR increase materially above 2.2x for a sustained period of time, resulting from weaker-than-expected operating performance and/or further debt-financed acquisitions, the ratings could be pressured. DBRS notes that pro forma the Acquisition, free cash flow as a percentage of debt should remain strong at over 20%.

DBRS does not expect Saputo to have difficulty in obtaining regulatory approval to complete the Acquisition, although minor divestitures may be required. Saputo’s ratings continue to be supported by the Company’s strong market position, geographic diversification and conservative financial management as well as the intense competitive environment, exposure to commodity price volatility and the risks of regulatory changes.

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 methodology is Rating Companies in the Consumer Products Industry, 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.