Morningstar DBRS Downgrades Corus Entertainment Inc. to B from BB (low) and Places Credit Ratings Under Review with Negative Implications

DBRS Limited (Morningstar DBRS) downgraded Corus Entertainment Inc.'s (Corus or the Company) Issuer Rating and Senior Unsecured Notes credit rating to B from BB (low). The recovery rating on the Senior Unsecured Notes remains RR4. Morningstar DBRS also placed the credit ratings Under Review with Negative Implications.

KEY CREDIT RATING CONSIDERATIONS
The credit rating downgrades reflect an unexpected and dramatic slowdown in earnings power that is projected to continue through the fiscal year end (August 31, 2024) and to also negatively affect F2025 results despite material cost-cutting efforts that were accelerated in Q3 F2024, notwithstanding the anticipated tailwind from external local news funding programs that are expected to begin sometime in F2025. Further, the loss of several Warner Bros. Discovery, Inc. specialty channel brands, including HGTV and the Food Network, is expected to create additional uncertainty around Corus' programming supply, despite the expectation that these channels will be rebranded with existing Canadian shows and new lifestyle content as of January 1, 2025. The Under Review with Negative Implications status reflects the material uncertainty related to Corus' ability to remain in compliance with the leverage covenants of its credit facility agreement as a result of anticipated weak operating performance in Q4 F2024 and the step down of the leverage covenants that will become effective on September 1, 2024. As a result, the Company disclosed that it is actively pursuing options to obtain relief from, or amendments to, terms with its lenders.

On November 28, 2023, Morningstar DBRS downgraded Corus's Issuer Rating to BB (low) from BB and changed the trend to Stable from Negative. At that time, Morningstar DBRS expected the advertising environment to remain challenging, but expected that the conclusion of the Writers Guild of America and Screen Actors Guild-American Federation of Television and Radio Artists strikes and an improving economic outlook would support a H2 F2024 recovery in television ad spending. As a result, F2024 EBITDA was expected to decline in the mid-single-digit range, compared with -24.7% year over year (YOY) in F2023, and for leverage to peak at 3.65 times (x) to 3.70x in F2024 before beginning to improve in F2025.

On July 15, 2024, Corus reported Q3 F2024 operating results (as of May 31), which were considerably weaker than forecast. Year-to-date (YTD) revenue and EBITDA were $1,001 million (-15% YOY) and $241 million (-16.2% YOY), respectively, reflecting material softness in Q3 F2024 of a revenue decline of 16% YOY and an EBITDA decline of 30% YOY, despite an easy annual EBITDA comparable of approximately -25% YOY. The EBITDA decline primarily reflected softer than expected television advertising revenue, which more than offset lower programming costs and a decline in employee compensation costs despite the impact of cost-cutting efforts during Q3 F2024 that includes the ongoing reduction of employees that commenced in F2023, and will total 800 or ~25% of the work force by year-end (YE) F2024. While Corus made a modest $4.6 million debt repayment in Q3 F2024, as a result of the weaker than expected EBITDA, the last 12 months ended Q3 F2024 gross leverage increased to 4.10x and is trending well above Morningstar DBRS' initial YE F2024 expectations.

CREDIT RATING DRIVERS
The Under Review with Negative Implications reflects the near-term uncertainty related to Corus' ability to remain in compliance with the leverage covenants of its credit facility agreement, amid the expectation that operating results will continue to weaken for the foreseeable future. It also acknowledges the short timeframe that the Company has to amend its credit facility agreement or pursue an alternative solution. As a result, a negative rating action will likely occur if the Company is unsuccessful in the negotiation of an amendment to its credit facility agreement.

Conversely, the ratings may be removed from Under Review with Negative Implications status if the Company is able to successfully negotiate an amendment to the credit facility agreement that is accepted by all stakeholders and enables Corus to remain in compliance with all applicable covenants.

EARNINGS OUTLOOK
Despite the return of a full program schedule in Q3 F2024 post the labour disputes in 2023 that disrupted content creation, as well as an improving economic outlook and a recovery in the Canadian advertising market, Corus has not been able to fully capitalize on these positive trends. While Corus' content-driven strategy continues to offer a solid lineup of popular programs, access to specialty channels and a production slate of Canadian content that has international appeal, the proliferation of advertising-supported digital entertainment options has intensified the competitive landscape, particularly across digital channels. Morningstar DBRS expects that Corus will continue to streamline its advertising buying experience, support continued growth in its digital properties; benefit from external local news funding programs, which are expected to commence in F2025; and will leverage continued cost-cutting efforts and operating efficiencies. However, material headwinds remain, including the anticipated rebranding of the HGTV and Food Network channels prior to January 1, 2025; an increase in Global primetime programming expenses in F2025 with the return to a normal schedule; and the continued proliferation of digital entertainment choices for consumers. As a result, Morningstar DBRS expects F2024 revenue to decrease in the mid-teens range and then decline in the low 20% range in F2025, despite the easy annual comparable. Reflecting the lower revenue outlook, while acknowledging the cost initiatives currently underway and the possibility of additional cost cutting measures, Morningstar DBRS expects F2024 EBITDA to decline in the high teens to 20% range and for a similar magnitude decline in F2025, which includes expected revenue losses related to the re-branding of HGTV and Food Network.

FINANCIAL OUTLOOK
In terms of the financial outlook, Morningstar DBRS estimates F2024 free cash flow after dividends and before changes in working capital will be between $40 million to $50 million, compared with Morningstar DBRS' prior forecast of between $110 million to $120 million, or roughly in line with the $48 million posted in F2023, despite the absence of $36 million in dividend payments included in F2023. While Morningstar DBRS expects the Company to continue to prioritize using internally generated cash flow toward reducing the balance of its term facility for the foreseeable future, the modest decrease in debt is expected to be more than offset by a decline in EBITDA. Therefore, despite a modest YOY reduction in debt and reflecting a material decline in EBITDA, YE F2024 gross leverage is expected to be over 4.25x and over 5.0x in F2025.

CREDIT RATING RATIONALE
Corus' credit rating ratings are supported by its ability to create unique Canadian shows and its broad programming appeal across multiple formats and its growing streaming portfolio. The credit ratings also acknowledge the structural shift in advertising spend to digital channels from traditional media, persistent cord cutting, and the growing selection of media and entertainment options to consumers.

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 (January 23, 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 Corus Entertainment Inc., the relative weighting of the BRA factors was approximately equal.

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

(C) Weighting of the BRA and the FRA
In the analysis of Corus Entertainment 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 methodology:

Global Methodology for Rating Companies in the Broadcasting Industry (April 15, 2024) https://dbrs.morningstar.com/research/431165

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 criteria 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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