DBRS Assigns Ratings to CanWel Building Materials Group Ltd.

DBRS Limited (DBRS) assigned an Issuer Rating of B (high) with a Stable trend to CanWel Building Materials Group Ltd. (CanWel or the Company). Concurrently, DBRS assigned a provisional rating to the Company’s proposed Senior Unsecured Notes of B (high), with a recovery rating of RR4 (the Proposed Notes). The ratings are supported by CanWel’s well-established market positions in the building materials and related products industry as well as diversified customer and supplier bases, the industry’s relatively high barriers to entry and the value of its timberland holdings. The ratings also reflect the significant cyclicality and seasonality associated with the building materials industry, the intense competition, risks associated with growth through acquisitions, regulatory and environmental risks and the Company’s high dividend payout.

CanWel is proposing to issue $60 million of 6.375% senior unsecured notes (the Proposed Notes; underwriter’s option to increase the amount to $69 million) expected to mature in October 2023. The proceeds of the issuance are to be used to repay amounts drawn on the Company’s $300 million revolving loan facility; as such, credit metrics immediately after the new issuance are not expected to change.

The provisional rating on the Proposed Notes is based on DBRS’s review of a draft indicative term sheet, dated September 6, 2018; a draft description of notes dated September 12, 2018; and information provided by CanWel to DBRS as of September 14, 2018. The assignment of a final rating is subject to receipt by DBRS of all information and final documentation that is consistent with that which DBRS has already reviewed and that DBRS deems necessary to finalize the rating.

CanWel’s earnings profile has benefited from several acquisitions in recent years, which have meaningfully improved the Company’s geographic and product diversification, size and scale, as well as margin profile. Revenues have increased by approximately 75% since 2013, rising toward $1.3 billion during the last 12 months (LTM) ended Q2 2018 versus $0.7 billion in 2013. The increase in revenues has primarily been driven by several acquisitions and tailwinds in the U.S. and Canadian housing markets in recent years. EBITDA margins have improved meaningfully since 2013, increasing to 6.0% for the LTM ended Q2 2018 from 3.1% in 2013, driven by improved gross margins and the Company’s efforts to control selling, general and administrative (SG&A) expenses. Gross margins improved notably to 14.9% for the LTM ended Q2 2018 from 11.1% in 2013, largely because of an organic and acquisition-driven shift of CanWel’s sales mix to higher-margin segments and products. SG&A as a percentage of sales increased modestly to 8.8% for the LTM ended Q2 2018 from 8.1% in 2013 largely because of the October 2017 acquisition of Hawaii-based Honsador Building Products (Honsador), partially offset by CanWel’s continuous focus on operational efficiency, synergies and prudent cost management. As such, EBITDA increased to $76 million for the LTM ended Q2 2018 from $22 million in 2013. DBRS notes that the eruption of the Kīlauea volcano in Hawaii in early May 2018 has not meaningfully affected CanWel’s operations to date.

DBRS views CanWel’s financial profile as acceptable for the current ratings based on the Company’s reasonable leverage levels, despite its high dividend payout and free cash flow deficit, which, along with numerous acquisitions, has required external funding in recent years. Cash flow from operations increased meaningfully in line with earnings growth, rising to $46 million during the LTM ended Q2 2018 from $15 million in 2013. Capital expenditures (capex) have increased notably since 2013, rising to $14 million for the LTM ended Q2 2018 versus $1 million in 2013. Higher capex has largely been attributable to the implementation of CanWel’s new enterprise resource planning system; equipment upgrades at Jemi Fibre Corp. following its acquisition in 2016; and, more recently, costs related to the acquisition of Superior Forest Products, Inc.’s (Superior Forest Products) incomplete lumber pressure treating plant in 2018. Cash outlay for dividends increased significantly to $41 million for the LTM ended Q2 2018 from approximately $12 million in 2013 as a result of a number of equity issuances in recent years, despite CanWel’s per-share dividend remaining flat. CanWel’s per-share dividend remained high following the Company’s conversion to a corporation from an income trust in 2010, as the Company did not meaningfully recalibrate its dividend with the change in legal form. Since 2013, the Company has used a combination of equity issuances, convertible debentures and incremental debt to finance a number of acquisitions, mandatory debt repayments and any free cash flow deficits. As such, total debt (excluding operating leases) increased significantly to approximately $367 million as at the end of Q2 2018 from $85 million in 2013 (including approximately $43 million of convertible debentures, which were repaid in 2016). Nevertheless, combined with the meaningful growth in earnings, credit metrics improved significantly (i.e., lease-adjusted debt-to-EBITDAR of 5.07 times (x) and lease-adjusted EBITDA coverage of 6.28x for the LTM ended Q2 2018 versus 5.82x and 3.56x, respectively, as at the end of 2013). DBRS notes that CanWel’s debt balance is seasonally high at the end of the second quarter.

CanWel’s earnings profile is expected to remain relatively stable on an organic basis over the near to medium term. CanWel’s revenues should continue to grow to the $1.3 billion level in the near term, primarily driven by the acquisition of Honsador (approximately $200 million of incremental annual revenue), which closed subsequent to Q3 2017. Over the medium term, DBRS expects the Company’s revenues to benefit from ongoing tailwinds from the U.S. housing market, growing in the low single digits per year toward $1.4 billion. EBITDA margins should improve modestly over the near to medium term, as the Company continues to focus on growing its higher-margin segments and products, improving efficiencies, gaining operating leverage and achieving synergies. As such, DBRS expects CanWel’s EBITDA to grow to above the $80 million level over the near to medium term.

DBRS believes CanWel’s financial profile should remain acceptable for the rating category over the near to medium term, absent any debt-financed acquisitions that would result in credit metrics deteriorating to a level no longer acceptable for the current B (high) rating. Cash flow from operations should continue to track operating income, increasing to the $50 million level on an organic basis. Capex is expected to be relatively high for full-year 2018 in the $10 million to $15 million range due to costs associated with the acquisition of Superior Forest Products’ incomplete lumber pressure treating plant. After 2018, DBRS expects capex to remain relatively flat at approximately $5 million per year, primarily consisting of maintenance capex. DBRS expects cash outlay for dividends to increase in 2018 to approximately $45 million because of the equity issuances in 2017. DBRS does not expect CanWel to meaningfully increase its per-share dividend. However, DBRS notes that total cash outlay for dividends could increase if CanWel issues equity, increasing the number of shares outstanding as part of the financing of a meaningful acquisition. As such, DBRS expects the Company’s free cash flow (after dividends but before changes in working capital) to remain in a modest deficit position over the near to medium term. DBRS expects CanWel to use a combination of debt and equity to invest in growth through acquisitions and finance any free cash flow deficits. Should CanWel be challenged to maintain credit metrics in a range considered acceptable for the current B (high) rating (i.e., lease-adjusted debt-to-EBITDAR below 6.0x) as a result of weaker-than-expected operating performance and/or more-aggressive-than-expected financial management (debt-financed acquisitions or shareholder returns), a negative rating action could result.

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

The principal methodologies are Rating Companies in the Merchandising Industry and Rating Companies in the Forest Products Industry, including Appendix I – Timberland Operators, 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.

DBRS will publish a full report shortly that will provide addi¬tional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com