DBRS Morningstar Confirms Ratings on 407 International Inc., Maintains Negative Trend

DBRS Limited (DBRS Morningstar) confirmed 407 International Inc.’s (407 or the Company) Issuer Rating at “A” and the ratings on the Company’s Senior Bonds at “A,” Junior Bonds at A (low), and Subordinated Bonds at BBB. All trends remain Negative. The ratings continue to be supported by the long-term economic fundamentals of the catchment area and 407’s adequate liquidity position. The Negative trends mainly reflect the uncertainties related to 407's financial recovery, which depends on how fast economic activities return to normal and to what extent behaviour changes (e.g., working from home) made by Highway 407 ETR users because of the Coronavirus Disease (COVID-19) pandemic will persist.

The Company reported 1,695.7 million vehicle kilometers travelled (VKT) in 2021, representing a 13% growth on a year-over-year (YOY) basis. Revenues in 2021 reached $1,023.1 million, a 12.6% YOY growth but approximately 32% below the 2019 level, although better than expected. Because of a surge in omicron-variant coronavirus cases and the additional public health and safety measures introduced by the Province of Ontario (Ontario or the Province; rated AA (low) with a Stable trend by DBRS Morningstar) on December 19, 2021, traffic recovery was interrupted and the Company reported the monthly VKT in January 2022 at 47% below the 2019 level. Nonetheless, as the Province entered phase one of its reopening plan on January 31, 2022, traffic recovery resumed with the monthly VKT in February and March reported at 29% and 26% below the pre-pandemic levels, respectively. For Q1 2022, the Company reported VKT and revenue at 34.0% and 23.4% lower than the same period in 2019, respectively. DBRS Morningstar currently assumes that 407’s revenues will be 20% and 15% below the 2019 levels in 2022 and 2023, respectively, before reaching a full recovery in 2024; thereafter DBRS Morningstar expects the Company's revenue to gradually grow at a moderate pace similar to what had been observed before the pandemic (DBRS Morningstar base-case assumptions).

The Company still intends to maintain the senior debt service coverage ratio (DSCR), including shadow amortization, above 1.7 times (x) and the senior and junior cash interest coverage ratios (ICR), net of cash income taxes, at 2.0x, which represent the thresholds that DBRS Morningstar considers suitable for the current rating levels. Under those DBRS Morningstar base-case assumptions, and assuming no additional senior or junior indebtedness through 2025, the senior DSCR with shadow amortization and the senior and junior ICR will rise slightly above these thresholds in 2022 and then gradually improve over time.

DBRS Morningstar understands that the Company plans to issue under its short term base shelf prospectus dated March 31, 2022, medium-term subordinated debt in 2022, ranking pari passu with all existing subordinated bonds. From the proceeds of such issuance, $300 million will be used to refinance the existing Series 17-D1 Subordinated Bonds scheduled to mature in September 2022. Under the DBRS Morningstar base-case assumptions, and including certain additional subordinated bonds assumed to be issued this year, DBRS Morningstar forecast the total DSCR with shadow amortization to reach 1.50x in 2022, supportive of the rating of the subordinated bonds. This ratio is also expected to gradually improve as traffic returns, assuming no additional subordinated leverage through 2025.

The ratings could stabilize if the Company proves able to maintain the above ICR or DSCR thresholds on a sustainable basis. DBRS Morningstar may take a negative rating action if it becomes apparent that the Company will not be able to restore the above ICR or DSCR thresholds, or if 407’s liquidity becomes insufficient. The ratings may also be under pressure if the Company decides to further increase its leverage before traffic volume has sufficiently recovered.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance (ESG) factors that had a significant or relevant effect on the credit analysis.

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/396929..

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

The principal methodology is Rating Public-Private Partnerships (August 19, 2021; https://www.dbrsmorningstar.com/research/383244), 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 (May 17, 2022; https://www.dbrsmorningstar.com/research/396929).

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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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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