Morningstar DBRS Changes Trends on Kruger Products Inc. to Stable from Negative, Confirms Issuer Rating at BB and Senior Unsecured Notes Rating at B (high)

DBRS Limited (Morningstar DBRS) changed the trends on Kruger Products Inc.’s (Kruger Products or the Company) Issuer Rating and Senior Unsecured Notes (the Notes) credit rating to Stable from Negative. Morningstar DBRS also confirmed Kruger Products’ Issuer Rating at BB and the credit rating on the Notes at B (high). The Recovery Rating on the Notes remains RR6.

KEY CREDIT RATING CONSIDERATIONS
The credit rating actions acknowledge Kruger Products’ stronger-than-expected operating performance and credit metrics in 2023, and also reflect Morningstar DBRS’ expectation that Kruger Products’ credit risk profile will strengthen as the Company’s expansionary capital expenditure (capex) projects ramp up and reach full production capacity, thus driving further earnings growth over the medium term.

On March 28, 2023, Morningstar DBRS assigned an Issuer Rating of BB with a Negative trend to Kruger Products, and concurrently assigned a credit rating of B (high) with a Negative trend to the Company’s Notes, with a Recovery Rating of RR6. The Negative trends reflected Morningstar DBRS’ concerns that, against the backdrop of a challenging macroeconomic environment, Kruger Products could be challenged to grow EBITDA enough to support a sufficient level of deleveraging over the near to medium term given the Company’s aggressive debt-funded capex program. At that time, Morningstar DBRS commented that if Kruger Products delivered an operating performance in line with or better than Morningstar DBRS’ expectations such that Morningstar DBRS gained sufficient confidence that the Company could deleverage to a level appropriate for the BB credit rating (i.e., debt-to-EBITDA below 6.0 times (x)), the credit ratings outlook could stabilize.

Since Morningstar DBRS’ last credit rating action, Kruger Products reported full-year 2023 results. Revenue grew by 11.4% year over year (YOY) to approximately $1.9 billion in 2023, attributable to volume growth in both the Consumer and Away-From-Home segments, combined with the full benefit of pricing actions that were implemented in 2022. EBITDA margins improved to 12.7% in 2023 from 6.9% in 2022 on the back of these pricing actions, lower pulp prices and freight costs, and benefits from the Company’s efficiency-improving initiatives, including the shut-down of certain older and inefficient production assets at the Company’s Memphis manufacturing facility in early 2023. This improvement was moderated by persistent inflationary pressure on input costs, and higher manufacturing, warehousing and selling, general and administrative expenses. As such, EBITDA increased to approximately $240 million in 2023 from less than $120 million in 2022, considerably above Morningstar DBRS’ expectation of approximately $200 million. Combined with relatively stable debt levels YOY, debt-to-EBITDA improved to 5.0x in 2023 compared with 10.8x in 2022, and bettered Morningstar DBRS’s expectation of 7.5x.

CREDIT RATING DRIVERS
Should debt-to-EBITDA increase above 6.0x because of weaker-than-expected operating performance and/or more aggressive-than-expected financial management (i.e., further debt-funded capex in addition to the Sherbrooke Expansion Project), a negative credit rating action will result.

Conversely, Morningstar DBRS could take a positive credit rating action should the Company’s business risk profile meaningfully strengthen, combined with a commensurate improvement in debt-to-EBITDA to below 4.5x on a normalized and sustainable basis, based on growth in operating income.

EARNINGS OUTLOOK
Morningstar DBRS projects revenue to grow toward $2 billion in 2024, primarily attributable to volume growth as the facial tissue lines in both the Sherbrooke Expansion project and the Gatineau, Québec facility ramp up, and the TAD Sherbrooke Project reaches full production capacity. Looking ahead to the medium term, Morningstar DBRS forecasts revenue to grow to approximately $2.1 billion in 2026, driven by further volume growth as the Sherbrooke Expansion project continues to ramp up. Morningstar DBRS anticipates EBITDA margins will remain relatively stable in 2024 as the benefit from potential price increases and improving operating leverage could be offset by rising pulp prices; persistent, albeit easing, inflationary pressure on input and operating costs; and a change in mix as consumers continue to switch from branded to private-label offerings and change their pack sizes. In the medium term, however, Morningstar DBRS believes EBITDA margins should grow on the back of increased volumes of higher-margin tissue products combined with improving operating leverage. As such, Morningstar DBRS forecasts EBITDA to grow to approximately $250 million in 2024 and increase to above $270 million in 2026.

FINANCIAL OUTLOOK
Morningstar DBRS believes operating cash flow should continue to trend in line with earnings, growing to more than $190 million in 2024 from approximately $185 million in 2023, and toward $220 million in 2026. However, for 2024, Morningstar DBRS forecasts free cash flow (FCF) after dividends but before changes in working capital to remain in a net deficit position as capex, including the Sherbrooke Expansion project, increases to between $200 million and $220 million, and the gross dividend outlay increases modestly above 2023 levels. Kruger Products is expected to complete the Sherbrooke Expansion project by the end of 2024; consequently, Morningstar DBRS projects capex to decrease to between $50 million and $60 million per year in 2025 and 2026. The lower capex, combined with higher operating cash flow and a further modest increase in the gross dividend outlay should result in meaningful levels of FCF over the medium term. Morningstar DBRS expects the final phase of the Sherbrooke Expansion project to be debt-funded. Consequently, and notwithstanding the projected growth in EBITDA, Morningstar DBRS forecasts debt-to-EBITDA to increase to 5.5x in 2024, but remain well below the 6.0x level considered appropriate for the current credit rating category. That said, Morningstar DBRS forecasts debt-to-EBITDA to improve to approximately 4.5x by the end of 2026, on the back of the projected EBITDA growth and mandatory debt repayment.

CREDIT RATING RATIONALE
The credit ratings on Kruger Products continue to be supported by the Company’s strong brands and leading market position in the tissue products industry, stable demand, and significant barriers to entry. The credit ratings also reflect the intense competition, volatile input costs, and product/market concentration.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) 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 Kruger Products Inc., the relative weighting of the BRA factors was approximately equal.

(B) Weighting of FRA Factors
In the analysis of Kruger Products Inc., the relative weighting of the FRA factors was approximately equal.

(C) Weighting of the BRA and the FRA
In the analysis of Kruger Products Inc., 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 Consumer Products Industry, https://dbrs.morningstar.com/research/417460 (July 21, 2023) and DBRS Morningstar Global Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers, https://dbrs.morningstar.com/research/420063 (August 30, 2023).

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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