DBRS Confirms Element Fleet Management Corp. at BBB (high); Trend Stable

DBRS, Inc. (DBRS) confirmed the ratings of Element Fleet Management Corp. (EFN or the Company), including the Company’s Long-Term Issuer Rating of BBB (high) and Short-Term Issuer Rating of R-2 (high). The trend on all ratings is Stable. The Intrinsic Assessment (IA) for the Company is BBB (high), while its Support Assessment remains SA3. As a result, EFN’s final ratings are equalized with its IA.

KEY RATING CONSIDERATIONS
The ratings consider EFN’s strong franchise, underpinned by its leading position in the North American, Australian and New Zealand commercial fleet management business. The ratings also take into account the progress the Company has achieved in executing the transformation initiative launched in October 2018. Ratings also consider the Company’s improved but still elevated leverage, reliance on secured forms of wholesale funding, as well profitability metrics that still lag the DBRS peer group at the next rating level, even with improving results.

The Stable trend reflects DBRS’s expectation that the Company will maintain the positive trajectory in earnings while sustaining sound balance sheet fundamentals, including strong asset performance, ample liquidity and continuing solid access to the capital markets. The Stable trend also considers the solid long-term fundamentals for the commercial fleet industry, underpinned by the continuing trend of large corporates outsourcing the management of their commercial fleets to save costs.

RATING DRIVERS
A strengthened capital position and improved funding diversity, including lower asset encumbrance through the issuance of unsecured senior debt, could have positive ratings implications. Additionally, further success in executing the transformation plan resulting in a sustained improvement in profitability, while maintaining sound credit and asset performance would be viewed positively. Conversely, failure to successfully execute on the transformation plan resulting in materially lower than anticipated targeted profitability improvements, could result in negative ratings pressure. Additionally, a deterioration in the franchise evidenced by lower volumes and higher than expected client attrition, a sustained period of weakening credit performance, or elevated tangible leverage above 8.0x for a sustained period could result in negative ratings pressure.

RATING RATIONALE
EFN’s ratings reflect its entrenched top-tier commercial fleet management franchise, underpinned by its leading market positions in North America, Australia and New Zealand, as well as its robust menu of products and services. Importantly, the Company has reinvigorated its focus on its clients, including creating more touch points and enhanced client service, which has resulted in the restoration of its client retention rates to its traditional high levels, which was important for the ratings.

EFN is in the midst of a transformation plan which includes a series of actions focused on generating an estimated $150 million in run-rate pre-tax operating income improvements by the end of 2020, while strengthening the balance sheet and repositioning its 19th Capital asset. Through June 30, 2019, the Company has made notable progress on the plan, including the sale of several non-core assets and the stabilization of 19th Capital. Following the purchase of the equity interest it did not already hold in 19th Capital, EFN has installed a new management team that is focused on improving utilization within the fleet while selling idle assets. Of note, at the end of 2Q19, EFN had received CAD$50 million of cash distributions from 19th Capital evidencing the improvement in the underlying performance.

The Company’s 1H19 earnings results were improved year-on-year, reflecting higher syndication-related revenues along with improved net financing revenues and services income, as well as lower restructuring and transformation costs. Excluding the Company’s restructuring and transformation costs, pre-tax income totaled CAD$209.8 million in 1H19, up 53% from 1H18. These positive results followed a sizable loss in fiscal 2018, primarily due to the considerable impairment charge related to 19th Capital, along with a high level of restructuring and transformation costs. Importantly, underpinning the Company’s sound underlying earnings capacity is its fee-based business model, which generates a high level of predictable and recurring revenues.

With the execution of the transformation plan, EFN’s balance sheet position has also improved. Specifically, the deleveraging of the balance sheet is accelerating with the introduction of the Company’s syndication initiative, which is focused on selling finance receivables to third party institutions in the U.S. At June 30, 2019, tangible leverage was 6.9x, down from 7.8x at year-end 2018, and ahead of the initial plan target. Indeed, EFN is targeting a tangible leverage ratio of below 6.0x by year-end 2020. Funding continues to be reliant on secured forms of wholesale funding, but is diversified by investors and channels. Further, funding is well-aligned with the asset base limiting potential capital calls.

EFN’s risk profile continues to be sound with low credit risk exposure in its core fleet business, driven by a high component of investment grade clients. Meanwhile, residual value risk remains moderate and manageable, as the overwhelming majority of its client leases are open-ended.

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

The applicable methodologies are Global Methodology for Rating Non-Bank Financial Institutions (September 2019), which can be found on our website under Methodologies.

The primary sources of information used for this rating include Company Documents and S&P Global Market Intelligence. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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.

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