DBRS Morningstar Confirms British Columbia Ferry Services Inc. Ratings at A (high), Stable Trend

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and the Senior Secured Bonds rating of British Columbia Ferry Services Inc. (BC Ferries or the Company) at A (high) with a Stable trend. The confirmations are backed by a satisfactory recovery of the traffic volume, a stable debt level, and the proven support of the Province of British Columbia (the Province; rated AA (high) with a Stable trend by DBRS Morningstar), as well as the operating resilience and reliable management demonstrated by the Company, having weathered challenging conditions during the Coronavirus Disease (COVID-19) pandemic while maintaining healthy financial metrics.

BC Ferries' service levels have generally normalized. Vehicle and passenger volumes in F2022 were at 95% and 80% of the pre-pandemic levels, respectively, which were slightly better than expected. Further boosted by the $101 million of recognized revenue from the Provincial Safe Restart Funding, total revenues in F2022 reached $998.2 million, largely on par with the F2020 level. Total expenses also increased to $722.5 million, partially offsetting the higher revenue and leading to a total EBITDA of $275.7 million, also largely on par with the F2020 level. This, combined with lower scheduled loan repayments to the KfW IPEX-Bank GmbH (KfW), led to a debt service coverage ratio (DSCR) of 3.4 times (x) in F2022, which is higher than the DSCR in F2020. The vast majority of the received Safe Restart Funding had been recognized in revenue during F2021 and F2022.

Vehicle and passenger volumes in H1 F2023 (the six-month period ended September 30, 2022) reached 103% and 95%, respectively, of the H1 F2020 levels. During H1 F2023, total revenues (excluding the Safe Restart Funding) and operation and maintenance expenses went up by 26.9% and 10.9%, respectively, leading to a 53.2% increase in EBITDA compared with the same period in the prior year. As of September 30, 2022, BC Ferries reported a trailing 12-month DSCR at 3.47x.

Mainly based on the Company's Performance Term 6 (PT6) submission dated on September 30, 2022, DBRS Morningstar currently assumes that the annual passenger volume will continue to recover and achieve 95% and 97% of the pre-pandemic level in F2023 and F2024, respectively, under which scenario DBRS Morningstar expects the Company's DSCR to remain above 2.5x during the remainder of Performance Term 5 (PT5), which is supportive of the ratings. The prompt and meaningful government supports observed to date have also strengthened DBRS Morningstar's view of the essentiality of the services provided by BC Ferries. While DBRS Morningstar considers a rating upgrade to be unlikely at this time, the ratings can now withstand a temporary negative financial impact to a larger extent compared with DBRS Morningstar's view at the onset of the pandemic. Material and negative deviations from DBRS Morningstar's base-case assumptions during PT5 could still have a negative rating impact.

The Company currently anticipates preliminary feedback from the Commissioner in early 2023 regarding its PT6 submission, which included a $5.2 billion 12-year capital plan. According to such capital plan, approximately $2.2 billion in spending will be incurred during PT6 and, as a result, the Company's leverage will likely double by the end of PT6 unless the Province contributes directly to cover a meaningful portion of the expenditure. DBRS Morningstar takes comfort from the management's proven ability to fine tune its capital programs for efficiencies; however, it notes that such flexibility is not unlimited considering that BC Ferries has an aging fleet facing increasingly stringent emission requirements, and the Company has already deferred almost $700 million in capital spending since the beginning of the pandemic.

Notwithstanding, DBRS Morningstar expects the Commissioner's final determination for PT6 will contain adequate price cap flexibility to mitigate certain challenges BC Ferries is currently facing, such as the ongoing inflationary cost increases, significant capital spending needed to sustain its service levels, higher interest rates, as well as a potential economic recession. DBRS Morningstar is of the view that the outlook for the business remains relatively stable. However, while not expected, this view may change if the final PT6 decision by the Commissioner includes setting the target DSCR or debt-to-total capitalization ratio to a level that represents a material erosion from current target levels, i.e., 2.5x and 82.5%, respectively.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/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 (May 17, 2022).

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

The principal methodology applicable to the rating is Global Methodology for Rating Public-Private Partnerships (https://www.dbrsmorningstar.com/research/402155/global-methodology-for-rating-public-private-partnerships; August 30, 2022)

The rating methodology 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/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.

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

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