DBRS Morningstar Confirms Ratings on Federated Co-operatives Limited at BBB (high) with Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Senior Unsecured Notes rating of Federated Co-operatives Limited (FCL or the Company) at BBB (high) with Stable trends. The rating confirmations and Stable trends reflect the Company’s steady operating performance over the last 12 months and is supported by DBRS Morningstar’s expectations that FCL’s financial profile will continue to remain exceptionally strong for the current rating category, based on its low financial leverage. FCL’s ratings continue to be supported by the strong brand and market position of the Co-operative Retailing System (CRS), its co-operative structure, and the high barrier to entry of the refinery business. The ratings also continue to consider the cyclicality of refinery operations, geographic concentration, associated environmental and regulatory risks, and intense competition.

Going forward, DBRS Morningstar expects FCL’s earnings profile to continue to remain supportive of the rating category based on the staple nature of the products offered and the integrated nature of the CRS network, while taking into account the variance in crude oil and fuel prices, refiners’ margins, and capacity utilization of the refinery. DBRS Morningstar expects full-year revenues to increase materially from $9.0 billion in F2021 (period ended October 31, 2021) to around $12 billion in the current financial year (F2022) and remain relatively stable at this level in F2023, primarily driven by higher product prices in the Energy and Agriculture business segments and improvement in fuel volumes from pandemic lows. The topline assumptions take into account relatively stable fuel volumes in the near term, as well as full-year contributions from the recently acquired Husky operations for the Energy segment and volume growth in the Agriculture business segment, partially offset by modestly lower volumes for the Foods segment and a moderation in the Home and Building Solutions segment, which witnessed strong demand during the last two years. DBRS Morningstar expects EBITDA margins for the Energy business segment to improve moderately in the near term compared with F2021, primarily driven by relatively strong crack spreads, especially for diesel, because of the current supply shortages in the North American market, partially offset by increasing inflationary pressures in input costs, transportation costs, and wages. As such, DBRS Morningstar expects FCL’s EBITDA to increase from $1 billion in F2021 toward $1.1 billion in F2022 and F2023 but notes that the earnings remain susceptible to material variances in crude oil and fuel prices.

DBRS Morningstar expects FCL’s financial profile to remain exceptionally strong and continue to underpin the overall rating category, primarily driven by its low level of debt. Cash flow from operations is expected to continue to track operating income and remain near $900 million levels in F2022 and F2023. Capital expenditure is expected to increase meaningfully toward approximately $480 million in the near term as the Company continues to invest in growth and capital projects, including investments to achieve reduction in companywide emissions. DBRS Morningstar expects the Company to generate sufficient cash flow (after distributions but before changes in working capital) to invest in growth, and/or grow the Company’s cash balance for potential future investments. DBRS Morningstar expects debt increase in the near term to be limited to working capital or short-term business needs. As such, FCL’s credit metrics are expected to remain more than acceptable for the current ratings (i.e., lease-adjusted debt-to-EBITDA below 1.25 times) over the forecast period. Should the Company’s credit metrics weaken beyond the range as a result of weaker-than-expected operating performance and/or more aggressive financial management, the ratings could be pressured. Conversely, a positive rating action would require a very meaningful improvement in the Company’s business risk profile.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
General Considerations

Environmental (E) Factors
DBRS Morningstar considered Carbon and Greenhouse gas costs as a relevant environmental factor. This factor is relevant because compliance with ever-increasing environmental regulations and standards limits the growth potential and adds costs for all oil and gas companies, including FCL.

Social (S) Factors
There were no Social factors that had a significant or relevant effect on the credit analysis.

Governance (G) Factors
There were no Governance 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/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

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

The principal methodologies are Global Methodology for Rating Companies in the Merchandising Industry (September 2, 2022; https://www.dbrsmorningstar.com/research/402334); Global Methodology for Rating Companies in the Oil and Gas and Oilfield Services Industries (August 31, 2022; https://www.dbrsmorningstar.com/research/402196); 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 (May 17, 2022; https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings).

In assessing the business risk of FCL, DBRS Morningstar accounts for the merchandising methodology and Oil and Gas (O&G) methodology on roughly equal basis. DBRS Morningstar uses the merchandising methodology to cover the integrated nature of the Company’s wholesaling business and the O&G methodology to review the risks related to FCL’s refinery operations. DBRS Morningstar also considers the income derived from each of these areas, the interrelationship between them, and any diversification benefits.

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223/interplay-of-global-corporate-finance-rating-methodologies-when-analyzing-corporate-finance-transactions

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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