DBRS Morningstar Changes Transcontinental’s Trend to Stable from Negative and Confirms Issuer Rating at BBB (low)

DBRS Limited (DBRS Morningstar) changed the trend on Transcontinental Inc.’s (Transcontinental or the Company) Issuer Rating to Stable from Negative and confirmed the rating at BBB (low). The trend change reflects Transcontinental’s stronger-than-expected operating results for F2020 and DBRS Morningstar’s expectations that comparable operating performance will continue to improve. DBRS Morningstar furthers expects that the Company will achieve ongoing leverage reduction over the near-to-medium term. The Company was swift to take action at the onset of the Coronavirus Disease (COVID-19) pandemic to maintain profitability in the Printing segment and deliver solid free cash flow (FCF) despite market pressures. While uncertainties related to the pace of the anticipated economic recovery remain, Printing segment profit has stabilized and the Packaging segment continues to perform well on a comparable basis, which has enabled the Company to direct a considerable amount of FCF toward debt reduction. As a result, DBRS Morningstar believes that Transcontinental is well placed to navigate the current operating environment within the current rating category.

The rating confirmation reflects the significant benefits of diversification that the Company has experienced with the Packaging segment, which now represents 55% of consolidated F2020 revenue (up from approximately 11% in F2016). The rating reflects Transcontinental’s continued strong market position in the print industry, attractive outlook in the Packaging segment, diversified customer base and product offering, and strong FCF-generating capacity. The rating also continues to consider the structural shift from print to digital media and the risks associated with growth through acquisition.

On July 9, 2020, DBRS Morningstar changed the trend on Transcontinental’s Issuer Rating to Negative from Stable and confirmed the Issuer Rating at BBB (low). The trend change reflected DBRS Morningstar’s view that Transcontinental’s near-to-medium term earnings profile would be negatively affected by the pandemic’s impact on the structural trajectory of the Printing segment. As such, DBRS Morningstar was concerned that the business risk profile and corresponding key credit metrics could deteriorate beyond the level considered appropriate for the rating category.

Since then, Transcontinental’s F2020 revenues were pressured primarily by revenue contraction in the Printing segment as advertisers adjusted to the initial impact of the coronavirus pandemic. Reported revenue for F2020 declined 15.3% year over year (YOY) to $2,574 million, or down approximately 10% YOY on a comparable basis excluding the impact of divestitures. After a solid start to the first five months of F2020, revenue for the Printing segment declined in the mid-40% YOY in April 2020, before recovering to an annual segment decline of approximately 15% YOY. Partially offsetting the revenue pressure in the Printing segment were the performances in the Packaging and Media segments, which saw market share gains in educational book publishing during the year. Despite pandemic-related revenue pressure in F2020, DBRS Morningstar EBITDA (Adjusted EBITDA) performance exceeded DBRS Morningstar’s expectations. F2020 Adjusted EBITDA of $520 million was up more than 2% YOY compared with DBRS Morningstar’s expectation of a double-digit decline. The better-than-expected performance reflected the strong operating results in Packaging, the benefits of major cost-control initiatives within the Print segment, the Canada Emergency Wage Subsidy (CEWS) program, the implementation of Corporate cost controls, and wage reduction for senior management, which were partially offset by volume declines in the Printing segment. Improving revenue trends continued in Q1 F2021 as Adjusted EBITDA was $111 million, down 3.2% YOY, and growth in Packaging and Media were offset by a decline in Printing segment results.

In terms of the Company’s financial profile, F2020 FCF after dividends and before changes in working capital increased to $256 million from $146 million in F2019 (+76.2% YOY), primarily reflecting higher net income (+9.0% YOY) and a lower level of capital expenditures (-22% YOY). Transcontinental continued to prioritize debt reduction and paid down $397 million of debt, thus ending the year with $1.2 billion of debt. As a result, despite the challenging operating environment, gross debt-to-Adjusted EBITDA decreased to 2.26 times (x) in F2020 compared with 2.87x in F2019 and performed better than expected. In Q1 F2021, with operating performance improving in each consecutive quarter, Transcontinental continued to reduce gross debt. Debt in Q1 F2021 declined by $89 million to $1.1 billion, resulting in last 12 months as of Q1 F2021 gross debt-to-EBITDA of 2.07x compared with 2.26x at F2020. DBRS Morningstar notes that Transcontinental has acceptable access to liquidity including FCF generation, an estimated $429 million in unused credit facilities, and $182 million in cash and equivalents as of Q1 F2021, which are sufficient to fund upcoming debt maturities in F2021.

DBRS Morningstar believes that the ongoing impact of the coronavirus pandemic and related containment measures will continue to pressure H1 F2021 Printing segment operating performance, but pandemic-related headwinds are expected to ease in the second half of the year due to the rollout of vaccines across Canada and the anticipated movement toward a national reopening. As a result, Printing segment revenue is expected to be up in the high-single-to-low-double digits YOY in F2021, although Printing segment Adjusted EBITDA is likely to be down modestly as the federal CEWS payments received in F2020 have not been forecast by DBRS Morningstar through the last three quarters of F2021. Packaging segment operating performance is expected to face an unfavourable foreign exchange (FX) revenue impact in F2021. As a result, reported revenue is expected to be down modestly YOY despite DBRS Morningstar’s expectation of low-single-digit organic revenue growth in the Packaging segment. The unfavourable FX impact will also pressure Adjusted EBITDA as well as rising resin pricing; however, this operating pressure should be partially offset by ongoing cost saving initiatives such that Adjusted EBITDA declines are forecast to be in the mid-single-digit range. Finally, Media results are expected to be roughly flat YOY as the segment faces tough annual comparables in the latter half of F2021. On a consolidated basis, F2021 revenue is expected to be up in the low-single-digit range and Adjusted EBITDA in the range of $470 million to $480 million.

The continued allocation of cash flow toward debt reduction should enable Transcontinental to improve its key credit metrics in F2021 and strengthen the Company’s credit profile within the rating category. DBRS Morningstar forecasts FCF after dividends and before changes in working capital to be $210 million to $220 million in F2021 reflecting the lower level of net income, a moderate decline in annual capital expenditures and essentially flat dividend payments. The Company is expected to continue to prioritize using internally generated cash flow toward debt reduction for the foreseeable future, although Transcontinental has a history of using its balance sheet to fund accretive acquisitions that are followed by periods of concentrated deleveraging. DBRS Morningstar expects F2021 gross leverage to be approximately 2.06x.

Should gross leverage move in a sustainable manner to below 2.0x and the Company continues to grows the Packaging segment such that consolidated operating income grows on a consistent basis, a positive rating action may occur. Conversely, if ongoing deterioration in operating performance leads to an sustained erosion of market share and/or more aggressive financial management, the rating may be pressured.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodologies are Rating Companies in the Industrial Products Industry (January 29, 2021, https://www.dbrsmorningstar.com/research/372944) and Rating Companies in the Printing Industry (March 12, 2021, https://www.dbrsmorningstar.com/research/375263), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021, https://www.dbrsmorningstar.com/research/373262), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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 [email protected].

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar did have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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