DBRS Confirms Parkland Fuel Corporation at BB, Stable Trend

DBRS Limited (DBRS) 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 Senior Unsecured Notes remains RR4.

The rating action contemplates the Company’s announcement on March 14, 2018, that it intends on commencing a private offering of USD 500 million of senior unsecured notes due 2026 (the Proposed Notes). The Proposed Notes are expected to be direct senior unsecured obligations of Parkland and rank pari passu with all of Parkland’s existing and future senior unsecured indebtedness, and effectively subordinated to Parkland’s indebtedness pursuant to its credit agreement. Net proceeds from the Proposed Notes are expected to be used to repay amounts drawn on the Company’s credit facility. In addition, DBRS expects the limit on the revolving credit facility will be reduced materially in conjunction with the issuance of the Proposed Notes.

The confirmation of the ratings is also based on Parkland’s acceptable operating performance in the Company’s base business, highlighted by a focus on cost controls across business segments as well as stable balance-sheet debt levels in line with DBRS expectations. DBRS notes the closing of the Acquisitions (of the majority of the Canadian assets of CST Brands, Inc. on June 28, 2017 (see DBRS press release, “DBRS Confirms Parkland Fuel at BB Following Agreement to Acquire Majority of CST’s Canadian Assets,” August 22, 2016), and Chevron Canada’s downstream fuel business on October 1, 2017 (see DBRS press release, “DBRS Confirms Parkland Fuel at BB Following Agreement to Acquire Chevron’s Western Canadian Marketing Assets and Burnaby Refinery,” April 19, 2017)), which were consistent with DBRS’s previous expectations. Overall, including the partial-year impact of the acquisitions, fuel volumes increased 28.0% year over year (YOY) to 13.3 billion litres.

Organic operating performance highlights included:

-- Retail Segment: Organic adjusted EBITDA increased in 2017, driven primarily by strong fuel margins which more than offset a 1.7% decline in fuel volume same-store sales growth. In addition, convenience store same-store sales increased 3.5%, and the adjusted gross profit on non-fuel sales remained relatively consistent YOY.

-- Commercial Segment: Organic performance in the Commercial segment was solid in 2017, driven primarily by growth in fuel volumes (including 36% growth in propane volumes) owing to strong organic growth efforts resulting in recent customer wins, the 2016 acquisition of PNE Corporation’s propane cylinder exchange program and improving macroeconomic conditions in certain regions of Canada. Adjusted gross margins were relatively flat YOY as strengthening distillate margins were offset by growth in lower-margin propane volumes. In addition, strong cost controls helped result in a decline in marketing, general and administrative (MG&A) on a cents-per-litre (cpl) basis in 2017.

-- Supply Segment: Organic adjusted EBITDA decreased YOY due to a decline in volumes in crude and liquefied petroleum gas, partially offset by improved performance in gasoline and diesel as well as progress in the Company’s supply strategy and decreases in operating costs and MG&A.

-- Parkland USA Segment: Organic adjusted EBITDA growth in the Parkland USA segment in 2017 was attributable to modest YOY growth in fuel volumes, particularly in the lubricants business (11%) as well as gasoline and diesel (3%) from new customer wins and the addition of three new sites in the retail division. Operating costs remained relatively stable in the segment YOY, therefore improving on a cpl basis.

Parkland’s financial profile remained in line with DBRS expectations through the end of 2017 as the Company completed the Acquisitions and ended 2017 with approximately $2.0 billion in balance-sheet debt.

Parkland’s earnings profile is expected to remain relatively stable at a level considered strong for the current BB rating over the medium term as the Company integrates its recent acquisitions, including achieving synergies while focusing on cost controls and driving growth (organically and possibly by additional acquisitions). Fuel volumes will benefit from the first full-year contribution of the recently acquired Ultramar and Chevron assets as well as modest organic growth. Gross margins on a cpl basis should continue to remain relatively stable over the longer term (given the new model mix because of the Acquisitions) and could improve modestly as Parkland leverages its scale in renegotiating supply agreements. Convenience store (C-Store) same-store sales growth is expected to benefit from the Company’s development of two new design concepts which are currently being tested under the On the Run/Marché Express banners. The two design concepts include a new flagship store model as well as retrofitting existing locations. Further, C-store sales and margins should benefit from the rollout and expansion of Parkland’s private-label product offering, named “59th Street Food Company,” which is expected to account for 20% of the total skew offering by the end of 2019. The contribution to earnings of Parkland’s Burnaby Refinery will be negatively affected in its first full-year in 2018 by the major turnaround in Q1 2018, which will decrease capacity utilization (toward 80% for 2018 versus 94.4% in Q4 2017) and production levels in addition to the expected normalization of refiners margins and crack spreads toward H2 2018 from currently elevated levels. EBITDA is expected to benefit from the fact that 85% of the costs of the turnaround will be capitalized versus previous expectations that the majority of the costs of the turnaround would be expensed. Parkland is expected to continue to focus on improving efficiency rates and reducing costs, including achieving synergies as it integrates its recent Acquisitions. DBRS forecasts that EBITDA should increase above the $550 million level and toward the $600 million level in 2018, and further toward the $700 million level as the refinery returns to normal levels of capacity utilization in 2019. DBRS notes, however, that these forecasts and the economic performance of Burnaby Refinery could be negatively affected by the ongoing dispute between Alberta and British Columbia related to the possible expansion of the Trans Mountain Pipeline, which have included the threat of a complete cut-off of oil exports to British Columbia.

Parkland’s financial profile is expected to improve over the near to medium term as the Company’s earnings and cash flow reflect the full contribution from recent acquisitions, leading to improving free cash flow generation and less reliance on participation in the Company’s Dividend Reinvestment Plan (DRIP). Cash flow from operations should continue to track operating income, increasing toward and above the $400 million level by the end of 2019. Capex is expected to be elevated, nearing the $250 million level in 2018, primarily because of the major turnaround at the Burnaby refinery but should moderate somewhat toward normal levels in the $175 million to $200 million level in 2019, which includes investments in growth, including new retail and commercial sites. Gross dividends are expected to increase moderately in the near term toward the $150 million level, primarily because of a modest increase in the per-share dividend and equity issuances in 2017 used to complete the Acquisitions. As such, free cash flow before changes in working capital (on a gross dividend basis) should be break-even or modestly positive in 2018, and then should rise substantially with the normalization of refinery earnings to above the $100 million level in 2019. DBRS expects any free cash flow in the near term will be used to repay debt and/or to complete minor tuck-in acquisitions. Over the medium term, DBRS believes that Parkland could use free cash flow and possibly incremental debt to continue to invest in growth through acquisitions, with a possible focus turning to growth in the Parkland USA segment, which recently appointed a new president. As a result of the growth in earnings, combined with potential for the repayment of debt, DBRS forecasts that Parkland’s key credit metrics, including lease-adjusted debt-to-EBITDAR, could improve meaningfully. If Parkland continues to display a successful integration of its recent acquisitions (including the achievement of synergies), and solid organic operating performance, combined with sustainably strong credit metrics (i.e., lease-adjusted debt-to-EBITDAR below 3.75 times (x), lease-adjusted EBITDA coverage above 4.5x and positive free cash flow after the gross dividend), a positive rating action could result.

Less likely, however, if key credit metrics are weaker than anticipated (i.e., lease-adjusted debt-to-EBITDAR above 4.25x) as a result of weaker than expected operating performance (including any potential operational issues at the Burnaby refinery or the achievement of expected synergies) and/or more aggressive than expected financial management (i.e., debt-financed acquisitions and/or increasing shareholder returns), the ratings could be negatively pressured.

As a result of the issuance of the Proposed Notes and associated repayment of the Company’s revolving credit facility, and the expected reduction of the limit on the revolving credit facility, DBRS expects the Recovery Rating on the Senior Unsecured Notes to strengthen but remain in the range appropriate for an RR4 recovery rating.

Notes:
All figures are in Canadian dollars unless otherwise noted.

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 for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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