Morningstar DBRS Changes Trend on Parkland Corporation to Positive, Confirms Ratings at BB

DBRS Limited (Morningstar DBRS) changed the trend on Parkland Corporation’s (Parkland or the Company) Issuer Rating and Senior Unsecured Notes rating to Positive from Stable and confirmed the ratings at BB. Morningstar DBRS also confirmed the Recovery Rating on the Company’s Senior Unsecured Notes at RR4.

KEY CREDIT RATING CONSIDERATIONS
The trend changes reflect a gradual strengthening of Parkland’s business risk profile, which has benefitted from the successful integration of the Company’s multiple acquisitions in recent years. Furthermore, the trend changes also acknowledge material improvement in Parkland’s key credit metrics in 2023, driven by stronger-than-expected operating performance as well as notable debt reduction.

On March 21, 2023, Morningstar DBRS confirmed Parkland’s ratings at BB with Stable trends. At the time, Morningstar DBRS stated that a positive rating action could occur if Parkland’s debt-to-EBITDA levels improved in line with Morningstar DBRS’ expectations to levels below 4.0 times (x) on a normalized and sustainable basis, primarily driven by growth in operating income, including through the successful integration of recent acquisitions.

Parkland has since reported its operating results for full-year 2023. EBITDA grew materially to approximately $1.9 billion in 2023 from $1.7 billion in 2022, benefitting from volume growth, relatively strong fuel margins, and the acquisition of the remaining 25% stake in SOL, which resulted in consolidation of the financial results, partially offset by a relatively lower contribution from refinery operations as a result of a planned turnaround. The Company allocated free cash flow of approximately $700 million, along with cash on hand, primarily toward debt reduction of approximately $750 million. As a result, key credit metrics improved materially in 2023, with debt-to-EBITDA improving to approximately 3.32x in 2023 from 4.13x in 2022 and cash flow from operations (before changes in working capital) as a percentage of debt, improving to above 20.0% from 16.8% in 2022.

CREDIT RATING DRIVERS
Morningstar DBRS could upgrade the ratings over the next two to four quarters if Parkland’s operating performance were to track in line with Morningstar DBRS’ expectations and key credit metrics were to remain at levels that are commensurate with a higher rating category (i.e., debt-to-EBITDA below 4.0x on a normalized and sustainable basis and EBITDA coverage comfortably above 4.5x). Conversely, although unlikely, Morningstar DBRS may change the trend back to Stable if weaker-than-expecting operating performance and/or aggressive financial management were to result in key credit metrics weakening again (i.e., debt-to-EBITDA ratio returns to above 4.0x).

EARNINGS OUTLOOK
Looking ahead, Parkland’s earnings profile is expected to remain relatively strong for the current BB rating category, benefitting from integration synergies and organic volume growth, partially offset by ongoing volatility in the fuel margins. In the fuel segment, Morningstar DBRS expects volumes to increase in the low-mid-single digits from 27.6 million litres in 2023, while fuel gross margins on a cents-per-litre (cpl) basis are likely to stabilize in the near term. Additionally, we expect higher refinery utilization during the rest of the year to be able to fully offset the negative affects related to the temporary shutdown at the Burnaby refinery in Q1 2024. Morningstar DBRS anticipates the food and convenience business to continue to grow in the low- to mid-single digits, benefitting from the M&M expansion rollout plans and enhancements to the rewards program with the introduction of Aeroplan partnership, as well as the full-year benefit of a convenience store network expansion in 2023. As such, Morningstar DBRS forecasts Parkland's EBITDA to increase toward $2.0 billion in 2024 and toward $2.1 billion in 2025.

FINANCIAL OUTLOOK
Parkland's financial profile is expected to remain relatively stable and strong for the current rating category, benefitting from growth in earnings, while debt levels remain relatively stable in the absence of any major leveraged acquisitions. Cash flow from operations should continue to track operating income, increasing to levels between $1.35 billion and $1.40 billion in 2024 and 2025, from approximately $1.3 billion in 2023. Morningstar DBRS anticipates capital expenditures to remain relatively stable at $500 million annually, while cash outflow on dividends should increase toward $260 million in 2025. The increase in dividends is partially due to the increase in the total number of shares, following the completion of the Sol acquisition-related share exchange. Morningstar DBRS expects that any free cash flow (after changes in working capital) will be used toward shareholder returns, modest debt reduction, or tuck-in acquisitions. As such, Morningstar DBRS expects Parkland's key credit metrics to remain relatively stable over the near to medium term, with debt-to-EBITDA leverage remaining around 3.5x in 2024 and 2025, largely within the Company’s publicly stated net leverage target of 2.0x–3.0x .

CREDIT RATING RATIONALE
Parkland's ratings continue to be supported by its strong market position, diversified customer and supplier base, geographic diversification, and the sector’s relatively high barriers to entry, while taking into account the industry’s competitive nature, exposure to economic cycles, and volatility in refinery margins, as well as relatively medium- to long-term risks associated with the electric vehicle transition.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
General Considerations

Environmental (E) Factors
Morningstar DBRS considered Carbon and Greenhouse Gas Costs as a relevant environmental factor for the Company’s refinery operations. 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 Parkland.

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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://dbrs.morningstar.com/research/427030 (January 23, 2024).

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)

(A) Weighting of BRA Factors
In the analysis of Parkland Corporation, the relative weighing of the BRA factors listed in the Merchandising methodology was relatively equal. For the Oil & Gas methodology section, the BRA factors were considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of Parkland Corporation, the relative weighting of the FRA factors was approximately equal.

(C) Weighting of the BRA and the FRA
In the analysis of Parkland Corporation, the BRA and the FRA carry approximately equal weight.

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

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

In assessing the business risk of Parkland, Morningstar DBRS accounts for the Merchandising methodology and Oil and Gas (O&G) methodology based on EBITDA contribution from the retail and refinery segment, respectively. Morningstar DBRS uses the merchandising methodology to assess the credit risk associated with the retail business of the Company, including gas stations and convenience stores, and the O&G methodology to assess the risks related to Parkland’s refinery operations. Morningstar DBRS also considers the income derived from each of these areas, the interrelationship between them, and any diversification benefits.

The following methodologies have also been applied:
-- DBRS Morningstar Global Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (August 30, 2023), https://dbrs.morningstar.com/research/420063

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

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.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.

Morningstar DBRS 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. Morningstar DBRS trends and credit ratings are under regular surveillance.

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

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