Morningstar DBRS Assigns Long-Term Issuer Rating of BB and Provisional Long-Term Senior Debt Credit Rating of BB (low) to Cooper Equipment Rentals Limited, Stable Trends

DBRS Limited (Morningstar DBRS) assigned a Long-Term Issuer Rating of BB with Stable trend to Cooper Equipment Rentals Limited (Cooper or the Company), reflecting an Intrinsic Assessment of BB and a Support Assessment of SA3. Morningstar DBRS also assigned a provisional Long-Term Senior Debt credit rating of BB (low). This one-notch differential reflects Cooper's substantial balance sheet encumbrance, as the vast majority of assets are pledged under the Company's asset based credit facility (the ABL Facility).

Cooper intends to issue senior unsecured notes (the Notes) of approximately $200 million, and the proceeds will be used to repay a portion of the ABL Facility and for general corporate purposes, including the payment of a special dividend. The Notes will be effectively subordinated to all secured indebtedness, including the ABL Facility, to the extent of the value of the assets securing such indebtedness.

KEY CREDIT RATING CONSIDERATIONS
The credit ratings reflect Cooper's franchise as one of the largest equipment rental businesses in Canada, with an estimated top-five market share. The Company's senior management team is experienced with a high degree of industry knowledge. Cooper's earnings generation is relatively resilient, underpinned by a diverse customer base, and revenue growth has been strong, driven by both organic growth and acquisitions. The Company has a sound risk profile including modest credit risk, while Morningstar DBRS considers asset risk and operational risk to be more relevant risk exposures. Morningstar DBRS views the Company's funding and liquidity profile as weak, with significant reliance on the ABL Facility. Although Cooper's tangible common equity ratio is low, Morningstar DBRS views cash flows as providing adequate loss absorption capacity. High cash flow leverage, including a long-term target range of 3.0 times (x) to 3.5x, is also a constraint on the credit ratings.

CREDIT RATING DRIVERS
Sustained improvement in financial performance along with a material increase in the scale of Cooper's franchise would lead to an upgrade of the Company's credit ratings. In addition, a sustained reduction in cash flow leverage would result in a credit ratings upgrade. The Long-Term Senior Debt credit rating would be equalized with the Long-Term Issuer Rating if asset encumbrance levels were reduced substantially.

Morningstar DBRS would downgrade the credit ratings if the Company's earnings deteriorate significantly or if cash flow leverage increases materially.

CREDIT RATING RATIONALE

Franchise Building Block (BB) Assessment: Good/Moderate
Founded in 1972, the Company has a well-established franchise in the Canadian equipment rental industry with a footprint of over 70 branches, primarily located in Canada's largest provinces. Cooper has an estimated top-five market share within a mostly fragmented industry which is led by two large U.S. companies. The Company rents over 53,000 pieces of equipment, including skid-steer loaders, compact track loaders, boom lifts, scissor lifts, telehandlers, forklifts, excavators, wheel loaders, rollers, dozers, articulated dump trucks, air compressors, generators, pumps, compaction, lighting, trench shoring, and a broad range of other general rental equipment and tools. Cooper is majority-owned by SeaFort Capital Inc. (SeaFort), a Halifax-based investment company whose founding investors include two of Canada's wealthiest families.

Earnings Building Block (BB) Assessment: Moderate
Earnings capacity has been relatively resilient, underpinned by a diverse customer base, and revenue growth has been strong, driven by both organic growth and acquisitions, including three acquisitions in F2023. A net loss of $15.7 million in F2023 was driven by a $30.7 million expense related to the issuance of shares to management. After adjusting for this expense and other one-time items, F2023 net income was $15.2 million, down one third from the prior year, reflecting a significant increase in interest expense from $16.0 million to $40.4 million, primarily related to the variable-rate ABL Facility. Expenses grew across all categories in F2023, but Cooper has achieved positive operating leverage over the past two years as the business has scaled, and its efficiency ratio improved to 72% in F2023, from 74% in F2022 and 78% in F2021.

Risk Building Block (BB) Assessment: Moderate
Cooper maintains a sound risk profile, reflecting a moderate degree of credit risk, with asset risk and operational risk considered to be more relevant risks. Asset risk is well-managed, as equipment is largely sourced from high-quality vendors and the Company employs a conservative depreciation approach, resulting in a fleet fair market value materially above net book value. While operational risk is moderated by the extensive industry experience of senior management and initiatives including a crisis management plan, various insurance policies, and telematics fleet coverage, Morningstar DBRS notes there is no formal risk management framework in place. Modest credit risk is evidenced by very manageable levels of receivables charged off which were just $0.4 million in F2023, down from $0.8 million in F2022.

Funding and Liquidity Building Block (BB) Assessment: Weak/Very Weak
Morningstar DBRS views Cooper's funding and liquidity profiles as weak. Funding is narrow in scope with a high reliance on the ABL Facility, supplemented by nominal vendor take-back loans as well as historical funding from related parties (none currently outstanding). Liquidity is also highly reliant on the ABL Facility, with no additional credit facilities available; at December 31, 2023, there was $185 million of undrawn capacity on the $800 million ABL Facility. Net cash inflows from operating activities totaled $70.5 million in F2023. The Company does not hold a cash balance as all cash collections are used to pay down the ABL Facility on a daily basis.

Capitalisation Building Block (BB) Assessment: Moderate/Weak
The tangible common equity ratio was a low 8.7% in F2023, down from 13.5% in F2022, driven by asset growth and higher intangibles and goodwill from acquisitions. Nonetheless, given the lack of substantial credit risk, the Company's cash flows provide an acceptable absorption capacity for unexpected charges. Adjusted cash flow leverage (i.e., debt/EBITDA), which has been relatively steady over the past five years, remains high at 4.0x in F2023, up from 3.7x in F2022 because of a higher ABL Facility balance. Cooper has a long-term target leverage range of 3.0x to 3.5x. Positively, SeaFort has demonstrated its ability and willingness to inject additional capital when required to finance accretive acquisitions.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Governance (G) Factors

The following Governance factor had a relevant effect on the credit analysis: Morningstar DBRS views the Corporate Governance factor as relevant to the credit ratings, but it does not affect the assigned credit ratings or trends. The Company is governed by a board of directors totaling five members, including two Cooper executives and three nonexecutive members who are founders and partners of SeaFort. The lack of independent directors, as well as the absence of formal audit or risk committees, indicates a weaker corporate governance structure and is considered within the Franchise Strength and Risk Profile grid grades.

There were no Environmental/Social 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 (January 23, 2024) https://dbrs.morningstar.com/research/427030.

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (April 15, 2024) https://dbrs.morningstar.com/research/431187. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030 in its consideration of ESG factors.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at dbrs.morningstar.com.

A provisional credit rating is not a final credit rating with respect to the above-mentioned security and may change or be different than the final credit rating assigned or may be discontinued. The assignment of the final credit ratings on the above-mentioned security are subject to receipt by Morningstar DBRS of all data and/or information and final documentation that Morningstar DBRS deems necessary to finalize the credit ratings.

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's outlooks and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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