DBRS Morningstar Confirms Issuer Rating on Cogeco Communications Inc. at BB (high), Stable Trend, Post Acquisition of Shares

DBRS Limited (DBRS Morningstar) confirmed Cogeco Communications Inc.’s (Cogeco or the Company) Issuer Rating at BB (high) and its Senior Secured Notes & Debentures credit rating at BBB (low) with a recovery rating of RR1. All trends are Stable. The confirmations reflect Cogeco's solid operating performance in the Canadian market, but also acknowledge the highly competitive U.S. market that has posed challenges, particularly in Ohio, and a marginal increase in leverage on account of a debt-funded share acquisition. The Stable trends reflect the expectation that both the Canadian and U.S. operations will grow in the low-single digits, excluding the incremental investment required to launch mobile operations in both regions, likely in late F2024 or early F2025. The credit ratings consider the Company’s established footprint in existing markets, the growth potential of the U.S. broadband segment Breezeline, and Cogeco's potential entry into the Canadian and U.S. mobile markets. The credit ratings also reflect intensifying competition, the risks associated with technological and regulatory changes, and the resources required to develop a successful wireless offering.

Cogeco’s F2023 earnings were driven by low-single-digit EBITDA growth at Cogeco Connexion, owing primarily to high-speed internet additions and the Company’s acquisition of oxio (completed in March 2023), which offset weakness in Breezeline. Cogeco’s F2023 consolidated revenue was $2.98 billion, up 2.9% year over year (YOY) or flat YOY on a constant-currency basis, driven by 3.4% growth at Cogeco Connexion and 2.3% growth at Breezeline. Breezeline faced a tough F2022 growth comparable of 30.7% YOY as the Company worked to integrate the WideOpenWest, Inc. (Ohio Broadband) acquisition and faced a highly competitive video and internet market. Adjusted EBITDA was $1.42 billion, up 2.0% YOY or -0.6% YOY on a constant-currency basis, reflecting growth in Cogeco Connexion. However, a challenging operating environment in the U.S. footprint related to a highly competitive video landscape, particularly in Ohio, partially offset this growth. The F2023 EBITDA margin was 47.6%, compared with 48.0% in the same period last year, in line with DBRS Morningstar's expectations.

Looking ahead, Cogeco is focusing on its strategy to expand its service offering to include wireless access. Including the recent $190 million investment in 3800-megahertz (MHz) spectrum licenses, the Company has 100% broadband footprint coverage by wireless spectrum and invested approximately $587 million in spectrum licenses to date. While continued operating investment is still required over the near to medium term, DBRS Morningstar believes that Cogeco’s earnings profile should ultimately strengthen if the Company is able to successfully enter the Canadian and/or U.S. mobile market.

DBRS Morningstar forecasts F2024 revenue to be flat or slightly up in the low-single digits, with growth in both the Canadian and U.S. markets. In F2025, DBRS Morningstar expects revenue growth to strengthen to the low- to mid-single-digit growth range, including the launch of a wireless service. DBRS Morningstar expects F2024 and F2025 EBITDA to come under pressure as a result of modest top-line growth and investment in the wireless service offering. As a result, F2024 and F2025 EBITDA will likely be flat to slightly down before resuming meaningful growth in F2026.

At year-end F2023, DBRS Morningstar’s free cash flow (FCF), though lower YOY, was better than anticipated even though leverage was modestly higher than expected. DBRS Morningstar’s operating cash flow was $1.10 billion in F2023 compared with $1.17 billion in F2022, reflecting slightly lower net income. Both capital expenditures and dividends increased YOY to $803 million (+7.8%) and $138 million (+6.2%), respectively. As a result, F2023 FCF (after dividends but before changes in working capital) was $120 million, down from $291 million in F2022. F2023 gross debt to EBITDA was 3.55 times (x), up from 3.36x in F2022 and modestly higher than DBRS Morningstar’s estimate. In terms of liquidity, Cogeco ended F2023 with approximately $263 million in unrestricted cash and equivalents, $375 million available on its $750 million Canadian credit facility that matures in January 2028, and USD 150 million (CAD 199 million) on the Breezeline credit facility that matures in July 2024. DBRS Morningstar notes that the Company has a modest USD 25 million (CAD 34 million) maturity in 2024 and a USD 215 million (CAD 291 million) maturity in 2025.

Looking ahead, DBRS Morningstar expects Cogeco’s financial profile to remain supportive of the current credit ratings. This outlook incorporates the recently completed 3800 MHz spectrum license auction, continued network spending in both the Canadian and U.S. markets, and the purchase of Cogeco shares. Reflecting both the investment to support a wireless service in both Canada and the U.S. and the purchase of its shares, DBRS Morningstar expects Cogeco's consolidated leverage to remain at their current levels in F2024 and F2025 before beginning to decline slowly through DBRS Morningstar's forecast horizon starting in F2026.

If wireline operating metrics deteriorate materially, the wireless service does not gain sufficient traction in the marketplace, and/or leverage moves structurally higher toward 3.5x to 4.0x, DBRS Morningstar may take a negative credit rating action on Cogeco’s Issuer Rating. Conversely, if operating performance reflects the successful expansion of Cogeco's service offering and the Company is able to deleverage in a manner that sustains core or non-acquisition-driven leverage below 3.0x, DBRS Morningstar may take a positive credit rating action on Cogeco’s Issuer Rating.

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/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (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 Communications Industry (July 20, 2023; https://www.dbrsmorningstar.com/research/417420/global-methodology-for-rating-companies-in-the-communications-industry).
-- DBRS Morningstar Global Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (August 30, 2023; https://www.dbrsmorningstar.com/research/420063/dbrs-morningstar-global-criteria-recovery-ratings-for-non-investment-grade-corporate-issuers).

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 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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