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

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and the rating on the Senior Unsecured Notes of Federated Co-operatives Limited (FCL or the Company) at BBB (high) with Stable trends. The rating confirmations and Stable trends reflect DBRS Morningstar’s expectations that FCL’s earnings profile will remain supportive of the credit rating category based on the staple nature of the products offered and the integrated nature of the Co-operative Retailing System (CRS) network while taking into account the variance in crude oil and fuel prices, refiners’ margins, and the refinery’s capacity utilization. Furthermore, FCL’s financial profile is expected to remain strong for the current rating category, based on its robust cash flow generating capacity and exceptionally low financial leverage. FCL’s ratings continue to be supported by the strong brand and market position of the CRS, its co-operative structure, and the high barriers to entry of the refinery business. The ratings also consider the relatively medium- to long-term risk from the electric vehicle transition, cyclicality of refinery operations, geographic concentration and competition, and other associated environmental and regulatory risks.

Looking ahead, DBRS Morningstar expects FCL’s earnings profile to remain relatively stable on a through-the-cycle basis in the medium term, despite ongoing inflationary headwinds and moderation in consumer demand, particularly in non-energy segments. DBRS Morningstar expects full-year revenues to remain flat at around $12 billion in F2023 (period ended October 31, 2023) and F2024, taking into account marginal growth in fuel volumes toward historic pre-pandemic levels as well as full-year contributions from the Husky operations for the Energy segment, partially offset by volume pressure in the non-energy segments, including the Foods and Home and Building Solutions segment. EBITDA margins for the Energy segment improved over the last 12 months in line with DBRS Morningstar’s expectations, primarily driven by relatively strong crack spreads, but refinery margins remain susceptible to material variances in crude oil and fuel prices, that coupled with inflationary pressures on input costs, transportation costs, and wages, are likely to pressure operating margins in the near term. As such, DBRS Morningstar expects FCL’s EBITDA to remain relatively stable at $1 billion in F2023 but decline toward $900 million in F2024.

DBRS Morningstar expects FCL’s financial profile to remain exceptionally strong and continue to underpin the overall rating category, primarily driven by the Company’s low level of debt. Cash flow from operations (before any working capital changes) is expected to continue to track operating income and to be around the $900 million level in F2023 and F2024. Capital expenditure is expected to remain relatively higher at approximately $400 million to $450 million annually as the Company continues to invest in growth and capital projects. DBRS Morningstar notes that while there is the possibility that FCL may undertake debt-funded energy transition projects, these haven’t been incorporated into the current forecast. DBRS Morningstar expects the Company to continue to generate sufficient cash flow (after distributions but before changes in working capital) to invest in growth and/or grow its cash balance for potential future investments. The current forecast assumes a limited debt increase in the near term, primarily for 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 that 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 while maintaining relatively strong key credit metrics.

ENVIRONMENTAL, SOCIAL, GOVERNANCE 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/416784 (July 4, 2023).

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

DBRS Morningstar applied the following principal methodologies:
-- Global Methodology for Rating Companies in the Merchandising Industry (the Merchandising methodology) (July 21, 2023; https://www.dbrsmorningstar.com/research/417461)
-- Global Methodology for Rating Companies in the Oil and Gas and Oilfield Services Industries (the O&G methodology) (August 16, 2023; https://www.dbrsmorningstar.com/research/419228)

In assessing the business risk of FCL, DBRS Morningstar accounts for the Merchandising methodology and 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.

The following methodology has also been applied:
-- DBRS Morningstar Criteria: Guarantees and Other Forms of Support (March 28, 2023; https://www.dbrsmorningstar.com/research/411694)

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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.

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 credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

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 credit ratings are under regular surveillance.

Information regarding DBRS Morningstar credit ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at [email protected].

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