Morningstar DBRS Confirms the Senior Secured Notes Rating of Reliance LP at BBB (low), Stable Trend

DBRS Limited (Morningstar DBRS) confirmed the Senior Secured Notes rating of Reliance LP (Reliance or the Company) at BBB (low) with a Stable trend.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmation and Stable trend reflect Morningstar DBRS' expectations that the Company's strong market position in the water heater and HVAC rental business in Ontario will continue to deliver stable earnings and operational cash flows that are supportive of the current credit rating. The current rating is underpinned by the Company's growing footprint in the long-term home services rental and maintenance business, recurring revenues supported by strong customer relationships and Reliance's incumbency advantage in Ontario. The Company provides essential services that are largely insulated from economic cycles.

On May 12, 2023, Morningstar DBRS confirmed Reliance's Senior Secured Notes credit rating at BBB (low), all with Stable trends. Since then, the Company reported results for the full-year ended December 2023 (F2023). Reliance achieved year-on-year (YOY) revenue and EBITDA growth of 8% to approximately $1.1 billion and $569 million, respectively. The performance was in line with Morningstar DBRS' expectations. The operational performance was supported by a low attrition rate and growth in HVAC unit sales, partially offset by the weaker new housing market in Ontario, and across Canada, which restrained water heater volume growth. The Company's free cash flow was moderately negative, after increased distributions and capital expenditure.

On May 7, 2024, Reliance issued 5.25% $400 million Senior Secured Notes (the Notes). The Notes rank pari passu with existing senior secured obligations of the Company. Proceeds from the issuance of the Notes will be used to repay outstanding indebtedness at the operating entity and at the holding company level. Morningstar DBRS assigned a credit rating of BBB (low), Stable trend, to the Notes.

CREDIT RATING DRIVERS
Morningstar DBRS may take a positive rating action if the Company achieves solid EBITDA diversification outside of Ontario in combination with cash flow-to-debt and debt-to-EBITDA ratios that are maintained at or above 25% and below 3.0x, respectively, for a sustained period. These thresholds take into account holding company obligations.

Conversely, Morningstar DBRS may take a negative credit rating action if the financial risk profile weakens to a level no longer commensurate with the current rating category (for example, if there is a significant increase in the leverage) and/or operational performance, including rental attrition, is materially below Morningstar DBRS' expectations for a sustained period.

EARNINGS OUTLOOK
Morningstar DBRS expects upper-single-digit revenue growth in F2024, attributable to a stable performance in the water heater and HVAC rental business, of which about 80% is recurring. Extended softness in the residential property market is expected to be offset by operational growth outside of Ontario, particularly the subsidiaries in Georgia and Florida that currently contribute approximately 10% of total revenue. The rental attrition rate is expected to remain under 5% (3.4% in F2023). EBITDA margins are expected to moderately soften by approximately 50-100 basis points from the three year average of ~53%, reflecting persistent inflationary pressure, and increases in the cost of inventory.

In the medium term, Morningstar DBRS expects Reliance's earnings profile will strengthen, supported by modest annual rental fee increases, and the growing penetration of HVAC units and other recently introduced product offerings. The Company is expected to extend its Western Canadian and U.S. footprint organically and through tuck-in acquisitions. A gradual shift in the product mix to advanced tankless water heaters and HVAC units and a conversion from a sales to a rental model outside Ontario are also expected to contribute toward keeping EBITDA margins above 50%.

FINANCIAL OUTLOOK
Morningstar DBRS expects cash flow from operations growth to trend in line with earnings. Reliance's leverage moderately increased in F2023 to finance suppliers and equipment, and for distributions to the holding company. Morningstar DBRS believes that the earnings profile and steady operational cash flow is supportive of the current credit ratings, notwithstanding the level of debt obligations on a consolidated basis.

CREDIT RATING RATIONALE
The credit rating is supported by Reliance's strong market position in the water heating rental business in Ontario, which generates stable high profit margins and operational cash flows. The credit rating is constrained by geographic concentration in Ontario. The water heating equipment rental sector is saturated, and, as such, the growth is constrained by new home construction, which can be volatile or less predictable. Furthermore, the credit risk profile of Reliance was evaluated using the consolidated approach in accordance with Morningstar DBRS Global Corporate Criteria (April 2024), particularly, the section for rating Corporate Holding Companies and Parent/Subsidiary Relationships.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Environmental (E) Factors
There were no Environmental factor(s) that had a relevant or significant effect on the credit analysis.

Social (S) Factors
There were no Social factor(s) that had a relevant or significant effect on the credit analysis.

Governance (G) Factors
There were no Governance factor(s) that had a relevant or significant 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 (23 January 2024) https://dbrs.morningstar.com/research/427030.

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

(A) Weighting of BRA Factors
In the analysis of Reliance, the relative weighting of the BRA factors was approximately equal.

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

(C) Weighting of the BRA and the FRA
In the analysis of Reliance, the BRA carries greater weight than the FRA.

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

Morningstar DBRS applied the following principal methodologies:

--Global Methodology for Rating Companies in the Services Industry (15 April 2024)
https://dbrs.morningstar.com/research/431185
--Morningstar DBRS Global Corporate Criteria (April 15, 2024)
https://dbrs.morningstar.com/research/431186

Morningstar DBRS credit ratings may use one or more sections of the the Morningstar DBRS Global Corporate Criteria (April 15, 2024, https://dbrs.morningstar.com/research/431186), which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodology and criteria have also been applied:

--Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://dbrs.morningstar.com/research/427030 (January 23, 2024).

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/431153.

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 info-DBRS@morningstar.com.

The credit rating was not 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 did not have 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 info-DBRS@morningstar.com.

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