DBRS Confirms Transcontinental Inc. at BBB (low) after It Announces Acquisition of Coveris Americas

DBRS Limited (DBRS) confirmed the Issuer Rating and Senior Unsecured Debt rating of Transcontinental Inc. (Transcontinental or the Company) at BBB (low) with Stable trends after the announcement of a definitive agreement to acquire the assets of Coveris Americas (Coveris), a business held by Coveris Holdings S.A., a portfolio company of Sun Capital Partners, Inc., for $1.72 billion (the Acquisition). Transcontinental is financing the Acquisition with cash on hand, drawing on the current revolving credit facility, a new banking term loan and a $250 million equity issuance. The Acquisition is subject to regulatory review and is expected by the Company to close in Q3 F2018.

Coveris is a leading flexible packaging manufacturer headquartered in Chicago that operates 21 plants and three research and development centres and has approximately 3,000 employees, primarily located in North America. The Acquisition significantly enhances Transcontinental’s penetration into the attractive flexible packaging industry, which is growing annually in the low-to-mid single-digit range and adds a portfolio of 3,500 clients. Coveris has established a strong market position in the majority of market segments in which it competes. Most market segments are staple in nature, including dairy, shrink film for beverages, pet food, agriculture and technical coatings. Subsequent to the transaction, Transcontinental will move from being a top 20 participant in the North American flexible packaging market to a top 10 participant and would benefit from diversifying its geographic footprint, customer base, product offering and sector coverage.

Although Transcontinental completed several prior packaging transactions, DBRS believes that the Acquisition, due to its size, is a transformational transaction that both complements and expands Transcontinental’s consolidated pro forma addressable market within the flexible packaging industry. Post the completion of the transaction, Packaging segment results will be reported separately from Printing and, on a pro forma basis, are expected to represent approximately 55% and 45% of revenue and EBITDA, respectively, compared with 15% and 11%, respectively, prior to the Acquisition. The Acquisition is consistent with Transcontinental’s strategy to invest incremental capital in businesses that have growth prospects, thereby reducing the exposure of earnings and returns related to the mature and declining Printing business and ultimately improving the Company’s business profile.

On a pro forma basis, Transcontinental’s F2017 (ended October 29, 2018) revenue and adjusted EBITDA would be approximately $3,300 million and approximately $560 million versus reported F2017 revenue and adjusted EBITDA of $2,007 million and $397 million, respectively.

Looking ahead, DBRS believes Packaging segment revenue should grow in the long term in the low-to-mid single-digit range and could be enhanced further by revenue synergies over the long term. As a result, DBRS forecasts consolidated revenue to remain essentially flat, despite an annual mid-to-high single-digit decline in Printing segment revenue performance through the forecast horizon. Consolidated pro forma EBITDA margins are expected to be in the high teens as a result of the increased contribution from the lower margin packaging business. Transcontinental is forecasting approximately USD 20 million (approximately $26 million) of acquisition-related cost-saving synergies within 24 months, a level DBRS believes is achievable. As such, DBRS forecasts annualized EBITDA should be approximately $525 million to $550 million per year over the DBRS forecast horizon.

DBRS believes that the benefits to the Company’s business profile as a result of the Coveris transaction afford the Company a higher leverage tolerance for an investment-grade rating than prior to the Acquisition. That said, based on the announced financing of the transaction, leverage will increase significantly to a level that DBRS considers aggressive for the BBB (low) rating, even when considering the more attractive pro forma business profile. DBRS estimates that at close, Transcontinental’s balance sheet debt will increase to approximately $1,550 million at close (around June 30, 2018) from $348 million at Q1 F2018 (ended January 28, 2018). As a result, LTM lease-adjusted debt-to-EBITDA is expected to increase to 3.56 times (x) at the close of the Acquisition from 1.08x as of Q1 F2018. DBRS forecasts free cash flow (after dividends but before working capital) of $250 million to $280 million per year, reflecting a similar pro forma capital intensity profile and a higher share count that reflects the equity raise.

In the near term, DBRS expects Transcontinental to refrain from any dividend increase, share repurchase activity or another large debt-financed acquisition and expects the Company to apply free cash flow-to-debt reduction. Based on Transcontinental’s ability and willingness to delever, DBRS forecasts lease-adjusted debt-to-EBITDA to decline to 3.16x as of Q4 F2018 (ended October 31, 2018) and to 2.33x as of Q4 F2019. While 2.0x to 2.5x is sufficient to maintain the current rating, moving toward the low end of this range or below by F2020 would place the Company very well within the BBB (low) rating. Credit metrics are expected to improve post the close of the Acquisition as the Company undergoes a period of deleveraging. EBITDA-interest coverage at close of 5.90x should improve to 7.56x at Q4 F2019, and cash flow from operations-to-debt at close of 22.6% should increase to 33.7% at Q4 F2019. DBRS notes that free cash flow of $250 million to $280 million would be approximately 30% of debt by F2020.

DBRS’s confirmation of the Issuer Rating reflects its view that the Company’s financial leverage will decline to 2.5x or less over the 18 months following the close of the Acquisition. Should Transcontinental not achieve this pace of financial deleveraging, a negative rating action could result.

Transcontinental’s ratings reflect the Company’s strong market position in its Printing business, expanding presence in flexible packaging and strong free cash flow-generating capacity. The ratings also consider the structural shift from print to digital media, heightened financial leverage and the risks associated with acquisition integration.

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

The principal methodologies are Rating Companies in the Printing Industry (March 2018), Rating Companies in the Publishing Industry (March 2018) and Rating Companies in the Industrial Products Industry (February 2018), which can be found on dbrs.com under Methodologies.

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 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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