DBRS Morningstar Confirms Transcontinental Inc.’s Ratings at BBB (low)

DBRS Limited (DBRS Morningstar) confirmed Transcontinental Inc.’s (Transcontinental or the Company) Issuer Rating and Senior Unsecured Debt rating at BBB (low). All trends are Stable. The confirmation reflects the Company’s expected improving organic growth in F2022, despite rising resin cost pressures in the near term. DBRS Morningstar expects that the Company’s deleveraging and diversification will continue to benefit its credit profile. The ratings reflect the significant benefits of diversification that the Company has experienced with the Packaging segment, which now represents 55% of consolidated F2021 revenue (up from approximately 11% in F2016). The ratings reflect Transcontinental’s continued strong market position in the print industry, attractive outlook in the Packaging segment, diversified customer base and product offering, and strong free cash flow (FCF)-generating capacity. The ratings also continue to consider the structural shift to digital media from print and the risks associated with growth through acquisition.

Reported revenue for F2021 increased 2.7% year over year (YOY) to $2,643 million, primarily reflecting the higher price of resin, the higher volume in the packaging sector, the positive impact of the 53rd week, and acquisition activity, partially offset by an unfavourable exchange rate. The F2021 DBRS Morningstar EBITDA of $475 million declined 8.8% YOY and was in line with DBRS Morningstar’s expectation. The EBITDA decline was primarily driven by the lag in passing through resin cost increases to customers, a smaller contribution from the Canadian Emergency Wage Subsidy (CEWS) program, the negative impact of foreign exchange, and higher variable compensation costs, despite ongoing cost reduction initiatives and the divestiture of the lower margin paper packaging business in the first quarter of 2020.

Rising resin prices and acquisition activity largely drove the trend of double-digit revenue in Q1 F2022, in which revenue was up 10.9% YOY to $691 million. DBRS Morningstar EBITDA of $89 million was down 19.6% YOY, reflecting the lag in passing through resin price increases, continued Coronavirus Disease (COVID-19) pandemic-related inefficiencies related to the omicron variant, the end of CEWS (representing approximately a $9 million benefit in Q1 F2021), and inflationary pressure on input costs and compensation.

In terms of Transcontinental’s financial profile, F2021 FCF after dividends and before changes in working capital declined to $181 million from $256 million F2020 (-29.4% YOY), primarily reflecting lower net income (-13.0% YOY) and higher capital expenditures (+41.8% YOY). After two years of only modest acquisition activity, Transcontinental acquired BGI Retail for $44 million in F2021. Although there was a modest reduction in debt to $1.13 billion from $1.18 billion, gross debt-to-adjusted EBITDA increased to 2.37 times (x) in F2021 compared with 2.26x in F2020. Despite the softness in Q1 F2022 operating income results, Transcontinental reduced gross debt in the quarter by $90 million, resulting in quarter-end debt of $1.07 billion. As a result, the last 12 months of as of Q1 F2022 gross debt-to-EBITDA was 2.36x, essentially flat with F2021.

Overall, all three operating segments are expected to post positive annual growth despite having a 53rd week in F2021 and the expectation of foreign exchange headwinds. By operating segment, Packaging revenue is expected to be up in the low-single-digit range on higher volume, which is also expected to drive positive margin leverage in F2022. Print revenue is expected to be up in the mid-single-digit range YOY, driven primarily by acquisition growth; however, the absence of federal wage subsidies in the segment are expected to pressure YOY margin performance. Media is expected to post mid-single-digit revenue growth, helped by growing in-store marketing and maintaining margins. On a consolidated basis, F2022 revenue is expected to be up in the low-to-mid-single-digit range and adjusted EBITDA in the range of $470 million to $480 million.

The continued allocation of FCF toward debt reduction should enable Transcontinental to improve its key credit metrics in F2022 and strengthen the Company’s credit profile. DBRS Morningstar forecasts FCF after dividends and before changes in working capital to be $100 million to $125 million in F2022, reflecting a slightly higher level of net income offset by higher 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 F2022 gross leverage to be at approximately 2.0x.

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 deterioration in operating performance leads to a 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 28, 2022; https://www.dbrsmorningstar.com/research/391382), Rating Companies in the Printing Industry (March 14, 2022; https://www.dbrsmorningstar.com/research/393671), and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (April 4, 2022; https://www.dbrsmorningstar.com/research/394683), 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 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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