DBRS Morningstar Confirms Doman at B (high) Following Acquisition of Hixson, Upgrades Notes Rating to B (high)

DBRS Limited (DBRS Morningstar) confirmed Doman Building Materials Group Ltd.’s (Doman or the Company, formerly CanWel Building Materials Group Ltd.) Issuer Rating at B (high) following the Company’s announcement that it has acquired all of the assets including inventory (“the Acquisition”) of the Hixson Lumber Sales group of companies (“Hixson”) for approximately USD 375 million (about $450 million) in cash. Concurrently, DBRS Morningstar upgraded Doman’s Senior Unsecured Notes rating to B (high) from B as a result of the improvement in the recovery rating from RR5 to RR4. All trends remain Stable.

While DBRS Morningstar acknowledges the merits of this Acquisition, including strengthening of Doman’s market position in pressure treated lumber products, increased scale of operations, and further penetration in U.S. markets, the rating actions also take into account the integration risks associated with this relatively large Acquisition and the projected increase in the near-term leverage. Doman’s ratings continue to be supported by its well established market position, diversified customer and supplier bases, and the relatively high barriers to entry. The ratings also factor in the high volatility in construction material prices, the significant cyclicality and seasonality associated with the building materials industry, the intense competition, and the Company’s high dividend payouts.

Hixson is a family-owned lumber and treated wood supplier operating in the central U.S. with 19 lumber-treating plants, five specialty sawmills, and a captive trucking fleet. Its operations are highly complementary to the Company’s existing U.S. West Coast operations without overlap. The Acquisition will also triple Doman’s sales in the U.S., thus providing increased revenue diversification between the U.S. and Canada. On a pro forma basis, DBRS Morningstar estimates revenues at approximately $2.7 billion for the combined entity in F2020 (year ended December 31, 2020). Hixson is being acquired on a cash-free and debt-free basis, and DBRS Morningstar believes the purchase price is consistent with the Company’s target guidance for acquisitions of 4.0 to 6.0 times (x) EBITDA. The Acquisition is being funded from the Company’s existing cash on hand and revolving credit facilities, which have been increased to $500 million from $360 million to facilitate this Acquisition. DBRS Morningstar notes that the Acquisition was completed on June 4, 2021, and is not subject to any further regulatory or shareholder approvals or consents.

On April 26, 2021, DBRS Morningstar upgraded Doman’s issuer rating to B (high) from B, taking into account the strengthening of Doman’s overall credit risk profile because of (1) the continued momentum in its earnings and operating cash flows and (2) its improved financial profile with an equity infusion of $86 million. Doman’s key credit metrics have improved meaningfully year over year (YOY), with debt-to-EBITDA decreasing to approximately 2.8x at the end of Q1 2021 from approximately 6.0x at the end of Q1 2020, benefitting from a demand surge for home improvement products and rising lumber prices in the last 12 months. At that time, DBRS Morningstar forecast Doman’s debt-to-EBITDA ratio in F2021 and F2022 to remain between 3.0x and 4.0x on a normalized basis as earnings moderate and the Company uses debt, along with cash flow from operations, to fund growth investments and shareholder returns. DBRS Morningstar also noted that the Company has undertaken a series of acquisitions in the past and may use the additional liquidity for future acquisitions and/or other growth investments.

Looking ahead, DBRS Morningstar expects organic operating earnings over the near to medium term to remain flat or decrease moderately as the Company faces not only tough YOY growth comparables but also potential challenges from evolving consumer behaviour and material price stabilization. That said, DBRS Morningstar still expects earnings to remain considerably higher than pre-pandemic levels in the near term as a normalization of demand for home improvement products is offset by a broad resumption in new construction activities. DBRS Morningstar forecasts revenues to be above $2 billion for F2021 on a reported basis as the earnings benefit from the Acquisition will be accretive only for roughly half the year and expects EBITDA margins to remain at high single-digit levels in F2021. As such, EBITDA is expected to be around $190 million to $200 million on a conservative basis as the earnings estimate continues to be subject to high volatility in the construction material prices.

In terms of financial profile, cash flow from operations should track operating income and continue to be above $100 million in F2021. Capital expenditure (capex) is projected to return to around $8 million from $3 million in F2020, as Doman had deferred or reduced capex during the pandemic. Cash outlay for dividends is expected to remain relatively flat vis-à-vis F2019 outlays at approximately $42 million to $44 million. As such, DBRS Morningstar expects the Company’s free cash flow (after dividends and capex but before changes in working capital) to remain above $50 million in 2021. Additionally, Doman raised more than $400 million earlier this year through equity infusion of $86 million and Senior Unsecured notes of $325 million, which supports the current Acquisition outlay of approximately $450 million. The increase in revolving credit facilities provides the Company with additional liquidity to manage the increased scale of operations and working capital requirements of the combined entity. Although the leverage ratio could increase toward the 3.5x to 4.5x range, modestly above the previously forecast 3.0x to 4.0x range on account of this acquisition and earnings moderation, it is still considered comfortable for the current rating category.

DBRS Morningstar believes that Doman’s business risk profile has meaningfully benefitted from the Acquisition and, while it expects organic operating earnings to moderate as the economy reopens and consumer spending shifts away to other discretionary sectors, ratings could be upgraded if the earnings profile remain relatively elevated even post-pandemic, the Company’s post-acquisition operating performance is satisfactory, and if capital allocation is managed so that Doman remains free cash flow positive, and financial leverage is sustained structurally in the 3.5x to 5.0x range on a through-the-cycle basis. Conversely, and though unlikely in the near term, if Doman were to experience a fundamental deterioration in earnings and its credit profile deteriorate as a result of a materially weaker-than-expected operating performance and/or more aggressive financial management, the ratings could 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 Merchandising Industry (July 30, 2020; https://www.dbrsmorningstar.com/research/364692), Rating Companies in the Forest Products Industry including Appendix I – Timberland Operators (March 16, 2021; https://www.dbrsmorningstar.com/research/375290), and DBRS Morningstar Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (August 24, 2020; https://www.dbrsmorningstar.com/research/366063), 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).

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 had 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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