DBRS Morningstar Assigns New Ratings to Shawcor Ltd.

DBRS Limited (DBRS Morningstar) assigned an Issuer Rating of BB (low) with a Stable trend to Shawcor Ltd. (Shawcor or the Company). DBRS Morningstar also assigned a provisional rating of B (high), Stable, with a recovery rating of RR5 to Shawcor’s Senior Unsecured Notes. As of November 30, 2021, Shawcor had no Senior Unsecured Notes outstanding. In connection with Shawcor’s proposed issuance of Senior Unsecured Notes, DBRS Morningstar expects the Senior Unsecured Notes to be on terms consistent with draft documentation provided by Shawcor to DBRS Morningstar and satisfactory to DBRS Morningstar, including guarantees (if any). Further, DBRS Morningstar (1) understands that the Senior Unsecured Notes will rank subordinate to the Senior Secured Credit facility, and (2) expects that, concurrent with the issuance of the Senior Unsecured Notes, the Senior Secured Credit facility will be reduced from USD 500 million to USD 300 million and its maturity will be extended to represent a 4 year term after the issuance of the Senior Unsecured Notes.

The assigned ratings are reflective of Shawcor's business and financial risk profiles. DBRS Morningstar notes that the Company’s exposure to the cyclicality of oil and gas commodity prices has declined over the last three years as a result of strategic asset dispositions in the pipe and pipe coating segment, and both organic and acquisition-driven growth in the non-oil-and-gas-related businesses. During the nine months ended September 30, 2021 (YTD 2021), the oil and gas related businesses accounted for approximately 60% of the Company's revenue, while the non-oil-and-gas-related businesses contributed the remaining 40% of the revenue. This compares to 2019, when more than 75% of the Company’s revenue came from oil-and-gas-related businesses.

All of the three non-oil-and-gas-related product lines of Shawcor, namely composite tanks, engineered wire and cable products, and heat-shrink products are supported by long-term sustainable macro-economic trends; Shawcor is the number one or number two player in their targeted geographies in each of these product lines. Shawcor is the second largest global manufacturer of heat-shrink products and application devices, the primary application of which is in electric and hybrid vehicles, and electric car components. These products are manufactured in China, Germany, and Canada. While competitor TE Connectivity is the clear global leader, when compared with other international producers in this space, Shawcor is technologically more advanced. The Company benefits from: (1) the growing penetration of electric/hybrid vehicles in the global automotive market; (2) the growth in the number of electric components per car in traditional internal combustion vehicles; and (3) the cost of failure being high, which leads to a preference for premium quality and reliability among customers. Thus, Shawcor has an advantage over other less sophisticated manufacturers. The Company is the largest manufacturer of composite tanks in North America with a substantial share of the growing composite underground fuel storage tank market. The majority of the sales are made to large national-level fuel stations for the replacement of steel underground fuel storage tanks and the Company is also gaining traction in the water-storage tank space. The Company continues to have a strong backlog of orders for its composite tanks driven by the natural replacement cycle and as certain large retail gas station networks are re-footing their infrastructure. Shawcor benefits due to the following underlying factors: composite tanks offer (1) a 30-year lifespan compared with the 20-year lifespan of steel tanks and (2) corrosion resistance leading to reduced risk of leakage. The Company is a Canadian leader in engineered wire and cables, with manufacturing in Toronto and sales mostly in Canada. The engineered wires and cables are sold to some of the key corporations in Canada within the communications, transportation, utility, and other industrial sectors. DBRS Morningstar is of the view that, moving forward, the percentage of total Company revenue and EBITDA contribution derived from heat-shrink products and devices, composite tanks and from engineered wires and cables will continue to rise.

Looking ahead, DBRS Morningstar views Shawcor's non-oil-and-gas product lines to be well positioned to take advantage of the favorable macro-economic trends in the near, medium, and longer term. Nonetheless, these businesses are expected to face headwinds during the next six to nine months driven by the same factors that have persisted during the last 12 to 18 months, namely:

(1) The Company has had difficulties in the procurement of Underwriter Laboratories listed resins, the key raw material used in the manufacturing of the composite tanks. This has led to the underutilization of the manufacturing units and prevented the Company from unconstrained fulfillment of its order backlog, which continues to remain robust. The issue is expected to be resolved by the second half of 2022 through a confluence of factors: (a) the Company has expanded from two to four suppliers, (b) Shawcor is searching for additional alternate sources of raw material, (c) the existing suppliers can likely supply more by increasing production to meet greater market demand, and (d) the Company is working to streamline its manufacturing process to reduce waste and thereby increase its product yield from the same volume of raw material inputs.

(2) The Company also has had its challenges on the automotive side as the chip shortage is now affecting the premium electric car segment, resulting in extended shutdowns at auto manufacturers. This will likely negatively affect the demand for Shawcor’s heat-shrink products from the auto sector until production returns to normal levels.

DBRS Morningstar believes that Shawcor's oil and gas businesses, specifically the pipeline and pipe services segment, is now leaner as the Company (1) shut down several of its plants during the course of the last year and now only operates through nine facilities versus 20 before; (2) reduced other fixed-costs through restructuring initiatives; and (3) in 2020 exited its North American onshore operations, save for those intended to service Western Canada. Note that this division was a relatively less specialized operation in a more competitive space as compared with the global offshore operations that remain. Additionally, in December 2020, the Company divested is Pipeline Products business, generating substantial cash and narrowing its go-forward focus. Even though a leaner division, the financial performance of the pipe and pipe coating segment continues to be highly correlated with activity levels in the midstream oil and gas industry, which in turn is influenced by oil and gas prices. Thus, it not only represents more volatile earnings and cash flows due to the continued exposure to a highly cyclical end market. F2020 was particularly challenging for this segment, resulting in negative segment EBITDA. Nonetheless, Shawcor's restructuring initiatives, namely rationalization of the manufacturing footprint throughout 2020 and 2021 and the reduction of fixed costs, along with the recovery in oil prices, have led to positive EBITDA for this segment on a year-to-date basis in 2021. Shawcor’s composite pipes product line, which is also tied to upstream oil and gas sector has much better margins and operating efficiencies as underpinned by profitable operation even during 2020 – a year particularly challenging for companies with upstream oil and gas sector exposure.

In terms of the financial risk profile, the Company has taken a number of steps to reduce its financial leverage including: (1) repayment of almost $130 million of debt YTD 2021; (2) the reduction in its capital spend; and (3) the suspension of its dividends starting in the second quarter of 2020. All of these factors, along with a year-over-year improvement in earnings and cash flow, have led to financial leverage measures in debt to EBTIDA falling to just under 3 times (x) during YTD 2021. (Note that DBRS Morningstar calculates financial leverage gross of cash, and includes operating lease liabilities as debt.) DBRS Morningstar expects leverage to increase slightly at year-end 2021 due to some supply chain issues. Nonetheless, DBRS Morningstar is of the view that financial leverage should decline in the second half of 2022 and stay under 3x for the foreseeable future. A substantial unfavorable change to the underlying business risk strengths and/or a protracted significant weakening of the financial risk profile, driven by factors including large debt funded acquisitions or reinstatement of dividends during market weakness, could lead to negative rating actions. Given the Company's commitment to a conservative financial policy, this seems less probable in the near term.

ESG CONSIDERATIONS

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), Rating Companies in the Oil and Gas and Oilfield Services Industries (August 16, 2021; https://www.dbrsmorningstar.com/research/383104), DBRS Morningstar Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (August 19, 2021; https://www.dbrsmorningstar.com/research/383238), and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (May 31, 2021; https://www.dbrsmorningstar.com/research/379424) 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).

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.

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

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