Morningstar DBRS Confirms 407 East Development Group's Issuer Rating and Long-Term Senior Bonds Credit Rating at A (low) With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed 407 East Development Group's (ProjectCo) Issuer Rating and Long-Term Senior Bonds credit rating at A (low). Both trends remain Stable. The credit rating confirmations are a reflection of ProjectCo's solid operating performance since substantial completion. The credit ratings continue to be supported by the availability-based revenue from the Province of Ontario (the Province; rated AA with a Stable trend by Morningstar DBRS) and the pass-down of all service period obligations, including lifecycle risk, to an experienced service provider.

KEY CREDIT RATING CONSIDERATIONS
ProjectCo is the special-purpose entity created to design, build, finance, maintain, and perform lifecycle obligations of the Highway 407 East Extension (the Project) under a 33.6-year project agreement with the Province. All risks and responsibilities pertaining to the routine and lifecycle maintenance during the service phase are passed down to another general partner, which is guaranteed and indirectly owned by AtkinsRéalis Group Inc. (formerly known as SNC-Lavalin Group Inc.; rated BB (high) with a Positive trend by Morningstar DBRS), Cintra Infrastructures SE (formerly Cintra Infraestructuras, S.A.), and Cintra Global SE (formerly Cintra Global Ltd.).

The Project has been in operation for more than eight years and has continued to perform well without incurring any failure points and any associated deductions to date. Therefore, ProjectCo's financial performance has continued to be stable since the opening of the highway.

According to ProjectCo's consultant's report dated February 2024, the pavement condition is currently assessed as good to excellent, and the current condition is projected to remain unchanged in the next several years. Because of the better-than-expected asset condition, the Project accumulated lifecycle cost savings of about $2.2 million as of June 30, 2024. In addition, the accumulated lifecycle cost savings has been deposited in the Lifecycle Deficiency Account.

In 2023, lifecycle cost was about $2.6 million, with nearly 60% of the total cost spent related to replacements such as equipment and cars. The remaining 40% of the lifecycle activities was related to pavements, structures, and systems.

The Project is now entering its first structural intervention (2024-27) as noted in Morningstar DBRS' rating report on ProjectCo published in 2023. The Service Provider, Protrans 407 East Development Group Inc. (a subsidiary of AtkinsRéalis Group Inc. (formerly known as SNC-Lavalin Group Inc.) and Cintra OM&R 407 East Development Group Inc.), will undertake considerably more lifecycle activities during this period, which will primarily entail asphalt rehabilitation and expansion joints. According to ProjectCo's 2024 lifecycle budget, lifecycle cost is expected to be around $9.4 million in 2024 (nearly half of the budgeted cost relates to pavement rehabilitation). In 2025-27, the annual lifecycle cost is projected to average about $12.7 million. Furthermore, ProjectCo indicated that the first major pavement rehabilitation could be extended from 2028 to 2031. Therefore, any unspent budgeted lifecycle amounts from 2024-27 would then be transferred to the Lifecycle Deficiency Account. Nevertheless, the Project is still expecting to rehabilitate 30% of the total road network in 2024-27.

CREDIT RATING DRIVERS
Morningstar DBRS notes that ProjectCo's relatively limited resilience to shocks in the lifecycle budget during operation (i.e., 20%) will likely constrain the credit ratings to a maximum of A (low). Morningstar DBRS could take a negative credit rating action if the Project's operating performance deteriorates significantly, leading to material deductions or an accumulation of failure points that may trigger various contractual thresholds. A negative credit rating action may also be warranted if there is a deterioration in the credit quality of the guarantors that are providing the performance guarantee to the Service Provider.

FINANCIAL OUTLOOK
ProjectCo has benefitted from the higher-than-expected interest rate, mainly through receiving higher interest income. Furthermore, it has incurred lower-than-expected third-party costs than projected at financial close. As a result, ProjectCo's debt service coverage ratio (DSCR) of 1.29 times (x) for the year ended December 31, 2023, was slightly above the projected DSCR of 1.26x. For the year ended June 30, 2024, the DSCR was 1.29x.

Despite the better-than-expected financial performance, ProjectCo's financial risk assessment is underpinned primarily by a lifecycle breakeven ratio of 20% and a projected minimum DSCR of 1.21x.

CREDIT RATING RATIONALE
ProjectCo's credit rating strengths are underpinned by (1) a superior lifecycle monitoring and reserving mechanism, and (2) good operating performance since substantial completion. The challenge relates to the risk of incurring higher-than-expected lifecycle cost driven by higher-than-expected traffic volume. However, the lifecycle risk has been passed down to an experienced service provider that will be responsible for any cost overruns or earlier-than-anticipated interventions.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/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 Factors in Credit Ratings (August 13, 2024) at https://dbrs.morningstar.com/research/437781.

RATING DRIVERS AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of Rating Drivers
In the analysis of ProjectCo, the relative weighting of the Rating Drivers listed in Part One - Rating Availability-Based PPPs of the methodology was approximately equal.

(B) Weighting of FRA Factors
In the analysis of ProjectCo, the following FRA factor listed in Part One - Rating Availability-Based PPPs of the methodology was considered more important: operating and maintenance and lifecycle breakeven ratios.

(C) Weighting of the Rating Drivers and the FRA
In the analysis of ProjectCo, the FRA carries greater weight than the Rating Drivers.

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Public-Private Partnerships (August 13, 2024),
https://dbrs.morningstar.com/research/437820

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (15 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 Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781

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 https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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