DBRS Changes Trend on AGT to Negative from Stable

DBRS Limited (DBRS) changed the trends on the Issuer Rating and Senior Unsecured Notes rating of AGT Food and Ingredients Inc. (AGT or the Company) to Negative from Stable and confirmed both ratings at B (high) and BB (low), respectively. The Recovery Rating on the Senior Unsecured Notes remains RR3.

The Negative trends reflect significantly weaker-than-anticipated earnings in 2017 (H2 2017 in particular) and the related use of incremental debt to fund the shortfall of cash for capital investments and working capital. Earnings were negatively affected in 2017 by volatility in pulse markets caused by oversupply, which included strong production in traditional import markets. The oversupply of pulse markets led to the imposition of tariff and non-tariff trade barriers by India, traditionally Canada’s top pulse export market and contributed to low pulse prices and lower volumes processed by AGT. In addition, global issues related to increased tension between Syria and Turkey led to incremental costs associated with changing trade flows to favour products from destinations other than Turkey for international aid agencies.

While DBRS expects earnings to improve in 2018 as pulse markets normalize and adapt to new market conditions, there remains concern over the pace of any recovery, which along with the incremental debt incurred in 2017, will extend the period in which credit metrics remain weak for the current B (high) Issuer Rating and make any meaningful recovery to levels considered appropriate for the current rating more challenging. Should the projected stabilization of pulse markets and a recovery in AGT’s earnings, as well as the repayment of debt with cash generated from working capital not materialize in 2018 and credit metrics not display a significant recovery toward a level considered more appropriate for the current B (high) Issuer Rating (i.e., total debt-to-EBITDA (including preferred securities) below 6.0 times (x) and EBITDA coverage above 2.5x), DBRS is likely to downgrade the ratings. Although DBRS has somewhat higher tolerance for volatility given the nature of the industry, in order to return the trend to Stable, AGT would need to continue to display growth and progress in its Food Ingredients segment, along with recovering earnings in its legacy business such that it does not require external financing, and credit metrics display significant improvement toward a level closer to supportive of the B (high) Issuer Rating.

Revenues declined approximately 12.1% year over year in 2017, primarily because of lower pulse volumes and sharp declines in prices driven by constrained global demand for imports. EBITDA margins declined materially year over year in 2017 because of compressed pulse margins, along with the effects of the tariffs in India and other increases in cost of sales (i.e., non-tariff trade barriers) where AGT filled existing orders with higher-priced products. In addition, the Company incurred certain one-time costs related to cargo in transit when the tariffs were imposed in India and political tensions between Syria and Turkey led to Syria no longer accepting products from Turkey. These one-time costs were estimated by the Company at approximately $11 million in Q4 2017. As such, AGT’s EBITDA declined materially to approximately $46.6 million in 2017 versus $110.1 million in 2016 and $93.7 million in 2015. AGT reported adjusted EBITDA, which aims to adjust for one-time costs, as described above, of approximately $64.9 million in 2017 versus $118.8 million in 2016.

AGT’s financial profile deteriorated meaningfully in 2017, primarily as a result of the decline in earnings as well as the increase in balance-sheet debt used to fund capex and working capital. Cash flow from operations tracked operating income, declining notably to $14 million in 2017 versus $79 million in 2016 and $68 million in 2015. Capex declined year over year but remained elevated at approximately $50 million in 2017 as the Company continued to invest in growth, completing ongoing projects including the addition of new capabilities at the Minot facility. The Company has indicated that capex should be in the $20 million per-year range. AGT’s dividend remained stable year over year at approximately $14 million in 2017. As such, the Company generated a free cash flow deficit of $51 million before changes in working capital, versus $18 million the previous year. Working capital requirements used approximately $61 million of cash in 2017, which the Company attributed to a notable decline in payables because of lower levels of deferred producer payments as North American farmers required cash for product sold at compressed prices and the Australian harvest was earlier in 2017 than the previous year. The Company issued $190 million in preferred securities to Fairfax Financial Holdings Limited in 2017. Proceeds from the issuance were used to repay amounts drawn on the Company’s credit facility. DBRS treats the preferred securities as debt since they are not subordinated to the Company’s Senior Unsecured Notes. The Company used debt to fund it cash flow deficit. As a result, total balance-sheet debt, including the preferred securities, increased to $685 million in 2017 versus approximately $568 million in 2016 and $496 million in 2015. The notable increase in total debt (including preferred securities) combined with the sharp decline in earnings has resulted in significant deterioration of credit metrics to a level no longer considered acceptable for the current B (high) rating including total debt-to-EBITDA (including preferred securities) of 14.7x at year-end 2017.

Going forward, DBRS believes that AGT’s earnings profile will remain under pressure in 2018, though some recovery could be expected in H2 2018 and in 2019 as pulse markets normalize (i.e., less acreage because of low prices, which leads to less supply and price increases). That said, EBITDA margins should display some recovery as pulse margins improve, while also benefitting from stronger margins in food ingredients driven by lower input prices while the Company focuses on improving efficiency and reducing headcount. As a result, DBRS believes EBITDA should begin to recover somewhat in 2018 toward the $70 million level, and could improve further with continued stabilization of pulse markets in 2019.

DBRS believes AGT’s financial profile should begin to recover in 2018 as cash generated from changes in working capital should help reduce short-term debt in the first half of 2018, while recovering earnings and lower capex should help limit the need for external financing. Cash flow from operations should continue to track operating income, while capex is expected to decline toward maintenance levels of approximately $20 million as the Company has completed many of its recent expansion projects. The Company’s dividend policy is expected to remain consistent with a cash outlay for common dividends of approximately $14 million. As such, DBRS forecasts free cash flow before changes in working capital to near the break-even level in 2018. Cash generated from changes in working capital should be meaningful in H1 2018, helping to reduce debt. As such, DBRS expects total debt including preferred securities to decline moderately in 2018, which combined with somewhat of a recovery in earnings should help return credit metrics toward a level that is more supportive of the B (high) 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 under Related Documents or by contacting us at info@dbrs.com.

The principal methodologies are Rating Companies in the Consumer Products Industry, DBRS Criteria: Recovery Rating for Non-Investment Grade Corporate Issuers, DBRS Criteria: Guarantees and Other Forms of Support and DBRS Criteria: Preferred Share and Hybrid Security Criteria for 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.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.