Morningstar DBRS Changes Trends on Saputo Inc. to Positive from Stable, Confirms Credit Ratings at BBB

DBRS Limited (Morningstar DBRS) changed the trends on Saputo Inc.'s (Saputo or the Company) Issuer Rating and the credit rating on its Senior Unsecured Notes (the Notes) to Positive from Stable, and confirmed the credit ratings at BBB.

KEY CREDIT RATING CONSIDERATIONS
Although Saputo's operating performance for the fiscal year ended March 31, 2024 (F2024), fell below Morningstar DBRS' projections and its key credit metrics deteriorated modestly as a result, the Company's credit risk profile remains supportive of the current BBB credit rating category. As such, Morningstar DBRS confirmed Saputo's credit ratings. Looking ahead, Morningstar DBRS expects the earnings benefits from the network optimization initiatives as outlined in the Company's Global Strategic Plan to ramp up such that key credit metrics improve to a level supportive of a BBB (high) credit rating, and are subsequently sustained at that level. Thus, Morningstar DBRS changed the trends to Positive from Stable. The trend changes also acknowledge that the productivity and efficiency gains stemming from these network optimization initiatives should strengthen the Company's business risk profile.

On July 25, 2023, Morningstar DBRS confirmed Saputo's Issuer Rating and the credit rating on the Notes at BBB with Stable trends. At that time, Morningstar DBRS commented that, in light of the uncertain macroeconomic backdrop, if debt-to-EBITDA improved below 2.5 times (x) on a normalized and sustainable basis based on growth in operating income, a positive credit rating action could result.

However, Saputo's F2024 results showed a deterioration in the Company's operating performance year over year (YOY). Revenue declined by 2.8% YOY to $17.3 billion, driven by market price fluctuations and lower export sales volumes, which more than offset the benefits of higher selling prices, including the carryover effect of pricing initiatives previously implemented, and stable domestic sales volumes. EBITDA margins remained flat at the F2023 level of 8.7% as pricing initiatives and productivity and efficiency gains from the network optimization initiatives more than offset the effect of commodity price volatility, higher milk costs in Australia, and the sell-off of inventory produced at higher milk prices in the UK. Consequently, EBITDA contracted to $1.5 billion in F2024 from $1.55 billion in F2023, falling short of Morningstar DBRS' expectation of more than $1.6 billion. Combined with relatively stable debt levels, debt-to-EBITDA increased modestly to 2.8x in F2024 compared with 2.7x in F2023, remaining higher than Morningstar DBRS' projection of less than 2.7x.

CREDIT RATING DRIVERS
In light of the expected uplift to Saputo's credit risk profile from the network optimization initiatives, Morningstar DBRS could upgrade the credit ratings over the next six to 12 months if key credit metrics improved to and were maintained as forecast at a level commensurate with a BBB (high) credit rating (i.e. debt-to-EBITDA of around 2.5x). Conversely, should debt-to-EBITDA persist notably above 2.5x as a result of either weaker-than-expected operating performance and/or more aggressive financial management, the trends could be changed to Stable.

EARNINGS OUTLOOK
Morningstar DBRS projects revenue to increase towards approximately $18.0 billion in F2025 and $18.5 billion in F2026 from $17.3 billion in F2024, attributable to higher selling prices and modest volume growth. As Saputo's investments in its network optimization initiatives are largely complete, Morningstar DBRS expects the benefits thereof including increased production of higher-margin, value-add products; manufacturing and labour productivity improvements; operating efficiency gains; and better fill-rates and operational stability to ramp up, leading to stronger EBITDA margins in F2025 and F2026. EBITDA margins should also benefit from higher prices. Morningstar DBRS believes that these benefits should more than offset the effect of commodity price volatility, persistent albeit easing inflationary pressure, elevated labour costs, and higher advertising and marketing spend. As such, Morningstar DBRS forecasts EBITDA to increase to approximately $1.7 billion in F2025 and to more than $1.8 billion in F2026, compared with $1.5 billion in F2024.

FINANCIAL OUTLOOK
Morningstar DBRS forecasts free cash flow (FCF), after dividends and before changes in working capital and principal lease payments, to increase to more than $600 million in F2025 and approach $700 million in F2026, from $228 million in F2024, as (1) operating cash flow trends in line with earnings growth, (2) capital expenditure tapers down to approximately $425 million as Saputo has completed most of the capital projects outlined in its Global Strategic Plan, and (3) the dividend policy remains consistent with previous years. Morningstar DBRS believes that the Company will continue to use its FCF, after changes in working capital and principal lease payments, in a balanced manner such that debt-to-EBITDA improves to 2.5x in F2025 from 2.8x in F2024, with further improvement in F2026.

CREDIT RATING RATIONALE
Saputo's credit ratings are supported by its leading market position, diversification of operations by distribution channel and geography, and strong FCF generation. The credit ratings also reflect the Company's exposure to volatile commodity prices, the highly competitive dairy processing industry, and the risks associated with the mature geographies in which Saputo operates, the largest of which Canada and the U.S. are heavily regulated.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
Since the last credit rating action the relevance of the following Environmental factor has changed: Morningstar DBRS considers Climate and Weather Risks a Relevant negative environmental factor for Saputo. Extreme weather events could result in (1) reduced availability of milk because of heat stress on livestock or reduced availability of quality feed crops and/or water and (2) operational disruptions that could consequently pressure the Company's operating performance and cash flow. The potential impact of such climate-related physical risks is mitigated by the global diversity of Saputo's milk supply, its capital investments to defend against natural disasters, and insurance. While the identification of Climate and Weather Risks as a Relevant negative factor is new and was not present in the prior credit rating disclosure, Climate and Weather risks have always been considered in Morningstar DBRS' assessment of Saputo's overall credit risk profile.

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

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of Saputo, the relative weighting of the BRA factors was approximately equal.

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

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

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Companies in the Consumer Products Industry (June 19, 2024;
https://dbrs.morningstar.com/research/434718).

Morningstar DBRS credit ratings may use one or more sections of 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 has also been applied:
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024; https://dbrs.morningstar.com/research/427030).

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 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 info-DBRS@morningstar.com.

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