DBRS Assigns Provisional Ratings to Kruger Products L.P.

DBRS Limited (DBRS) assigned a provisional Issuer Rating of BB and a provisional Senior Unsecured Notes rating of BB (low) with a Recovery Rating of RR5 to Kruger Products L.P. (KPLP or the Company). All trends are Stable. The ratings are supported by KPLP’s strong brands and market positions in the Canadian tissue products market, efficient production facilities and effective operations; stable tissue products demand; and the significant barriers to entering the tissue products market. The ratings also reflect the Company’s exposure to volatile commodity prices while operating in a highly competitive industry, single product/single-market exposure and the strong bargaining power of major retailers.

KPLP is 84% owned by Kruger Inc. and 16% owned by KP Tissue Inc., which is 100% held by the public. KP Tissue Inc. was created in December 2012 to acquire — and its business is limited to holding — an equity interest in KPLP. Kruger Inc. is a private Montréal-based Canadian corporation controlled by Joseph Kruger II.

DBRS’s provisional ratings on KPLP are being assigned on a stand-alone basis using the deconsolidated financial statements of KPLP, excluding K.T.G. (USA) Inc. (KTG) and certain other subsidiaries (the Unrestricted Subsidiaries). KTG owns two paper machines and one adjacent through-air-drying (TAD) tissue machine. KTG has an established private-label product portfolio with U.S. customers; in addition, KTG previously sold products exclusively to Walmart Inc. (rated AA with a Stable trend by DBRS) under the White Cloud brand but is now expanding its distribution to other retailers. The Company’s facilities consistently operate at high levels of capacity utilization. There is currently USD 147 million of debt at KTG, which is secured by all the assets of the Unrestricted Subsidiaries. As the operations of the Unrestricted Subsidiaries could have a meaningful impact on cash flows at KPLP — either positive or negative — DBRS has completed an analysis of these entities. DBRS notes that if KPLP was treated as a fully consolidated credit that includes the Unrestricted Subsidiaries, at this point in time, the Issuer Rating would likely be the same.

KPLP’s earnings profile is supported by its leading market position as a tissue products supplier in both the consumer and away-from-home (AFH) markets in Canada. Revenues have increased by approximately 23%, rising to almost $1.0 billion in 2017 from $0.8 billion in 2013. Revenue growth was primarily driven by increased sales volumes in the Consumer and AFH segments, supported by stable demand fundamentals and moderate market share gains, higher selling prices in Canada and the acquisition of certain assets of Metro Paper Industries Inc. in June 2014. EBITDA margins decreased to 9.2% in 2017 from 13.2% in 2013 primarily as a result of lower gross margins largely due to higher commodity costs. As such, KPLP’s EBITDA decreased by 14% to $91 million in 2017 from above $100 million in 2013.

DBRS views KPLP’s financial profile as supportive of the current ratings based on the Company’s modest leverage for the rating category and relatively stable cash-generating capacity. KPLP’s cash flow from operations increased by 15% to $73 million in 2017 from $64 million in 2013. Capital expenditures (capex) have been elevated in recent years, totalling $63 million in 2017 from a steady state of approximately $35 million, due to increased production capacity. KPLP’s gross dividend payments (excluding the Company’s dividend reinvestment program (DRIP), tax distributions and advances paid) have increased to approximately $41 million in 2017 from approximately $31 million in 2013. The increase in the Company’s cash flow from operations was not enough to offset the increase in capex and gross dividends in recent years, which consequently resulted in a free cash flow deficit (before changes in working capital and after gross dividends) of approximately $30 million in 2017 versus positive free cash flow of $18 million in 2013. The Company has funded its free cash flow deficit primarily with cash on hand and debt. As such, the Company’s cash balance decreased to $3 million in 2017 from $119 million at the beginning of 2013, and its balance sheet debt increased to $244 million in 2017 from $216 million in 2013. This, combined with the decrease in EBITDA, has resulted in a modest leverage increase (i.e., lease-adjusted debt-to-EBITDA of approximately 3.12 times (x) in 2017 versus 2.43x in 2013). Despite the decline in EBITDA, reduced interest expenses resulted in improved lease-adjusted EBITDA coverage of 7.26x in 2017 versus 5.61x in 2013.

KPLP’s earnings profile is expected to remain relatively stable through the pulp cycle based on moderate revenue growth and modest EBITDA margin improvements. Revenues should continue to grow in the low single digits over the medium term, in line with inflation and population growth. Revenue growth is further supported by KPLP’s 20,000-metric-tonne expansion at the Company’s Crabtree, Québec, plant (the PM8 plant), which was completed in September 2017. EBITDA margins could improve modestly as price increases in the industry are expected as a result of commodity cost increases in 2018, as well as productivity savings, other cost-cutting initiatives and price increases. As such, DBRS expects EBITDA to grow toward $100 million over the near to medium term.

KPLP is expected to issue $125 million of Senior Unsecured Notes, the proceeds of which are expected to be used to repay the amounts drawn on the Company’s revolving credit facility; as such, credit metrics immediately after the new issuance are not expected to change. DBRS expects KPLP’s financial profile to remain supportive of the current BB Issuer Rating despite a potential increase in leverage if a second TAD paper machine is built in a new Unrestricted Subsidiary. DBRS expects KPLP’s cash flow from operations to track operating income, increasing toward $80 million over the near to medium term. Capex outlay is expected to decrease toward the $35 million to $45 million range following the completion of the PM8 plant, with approximately $25 million allocated to routine asset maintenance and the remainder to expansionary initiatives. DBRS expects KPLP’s per-share dividend to remain stable but expects gross dividend outlay to continue to increase in line with DRIP participation. DRIP participation is expected to remain at current levels. Consequently, DBRS does not expect KPLP to generate a meaningful level of free cash flow (before changes in working capital and after gross dividends). DBRS expects KPLP will use any free cash flow after net dividends primarily for mandatory debt repayments. As such, KPLP’s credit metrics are expected to improve modestly on a through-the-cycle basis, in line with EBITDA growth and mandatory debt repayments. Should KPLP be challenged to maintain credit metrics in a range considered acceptable for the current BB Issuer Rating (i.e., lease-adjusted debt-to-EBITDAR below 4.0x) as a result of weaker operating performance and/or more-aggressive-than-expected financial management, a negative rating action could result.

DBRS notes that KPLP is currently evaluating the installation of a second TAD paper machine in a new Unrestricted Subsidiary. Should the Company finance a meaningful portion of the project with debt at KPLP, it could have a negative impact on the Issuer Rating or Recovery Rating on the Senior Unsecured Notes.

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

The principal methodologies are Rating Companies in the Consumer Products Industry and DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers, 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.

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at info@dbrs.com.