Morningstar DBRS Assigns Issuer Rating of BBB With a Stable Trend to Stella-Jones, Inc.

DBRS Limited (Morningstar DBRS) assigned an Issuer Rating of BBB to Stella-Jones, Inc. (Stella-Jones or the Company) with a Stable trend. Stella-Jones is a leading North American producer of pressure-treated wood products. Headquartered in Montréal, Québec, the Company manages a vertically integrated operation with an extensive manufacturing and logistics network.

KEY CREDIT RATING CONSIDERATIONS
The BBB credit rating reflects Stella-Jones' strong investment-grade business risk profile. Pillars of the Company's Business Risk Assessment (BRA) strength include its (1) market position in the utility poles and railway ties business, both of which exhibit low market volatility with attractive long-term demand fundamentals; (2) significant sales covered under-long term contracts with cost pass-through features, which materially mitigates inflation and commodity price volatility and resulted in reliable profit margins; (3) ability to finance and warehouse a significant amount of treated and untreated inventory to be able to provide security of supply to service its clients' needs; and (4) experienced senior management team with extensive industry knowledge.

CREDIT RATING DRIVERS
Morningstar DBRS may take a positive credit rating action if there is a material improvement in Stella-Jones' credit risk profile through material expansion into complementary products and/or a commitment to sustained improvement in the Company's financial risk profile. Although not currently anticipated, Morningstar DBRS may consider a negative credit rating action if Stella-Jones' debt-to-EBITDA approaches 3.5 times (x) on a sustained basis or if operating performance materially declines for an extended period.

EARNINGS OUTLOOK
Morningstar DBRS expects Stella-Jones' revenue to grow to $3.5 billion in 2024, largely due to strong growth in its utility poles product category. This would mark more than 20 years of year-over-year sales growth for the Company. Operating expenses as a percentage of revenues are expected to remain in line with previous years. Morningstar DBRS expects near- to mid-term growth to continue, bolstered by strong demand and positive long-term fundamentals across the Company's utility poles product category as well as steady demand for rail ties and replenished inventory levels, which allow it to capitalize on commercial sector growth while continuing to service its Class 1 customers. In addition, in 2025, Morningstar DBRS expects Stella-Jones' residential lumber product category may benefit from improved consumer demand after a flat 2024.

FINANCIAL OUTLOOK
Morningstar DBRS expects the Company to maintain a financial risk profile in the low-investment-grade range, with debt-to-EBITDA within the 2.0x to 2.5x range, other than brief deviations to pursue acquisitions or to fund seasonal working capital requirements. Morningstar DBRS forecasts that debt-to-EBITDA will improve to 2.4x in 2024 from 2.6x in 2023 as a result of EBITDA growth and debt reduction. Interest coverage will likely weaken modestly due to higher average borrowing rates. Stella-Jones is also likely to use operating cash flow to fund higher capital expenditures (capex) as the Company continues to focus on expanding capacity in its utility pole operations to support high levels of expected demand. Morningstar DBRS expects the Company will maintain its disciplined approach to capital allocation, which balances investment toward growth of its infrastructure-related business with returning capital to shareholders. The Company maintains adequate liquidity to fund its working capital and capex needs, supported by cash flow generation and two unsecured revolving facilities, composed of (1) a USD 600 million facility with a syndicate of lenders and (2) a U.S. Farm Credit facility of USD 150 million. As of June 30, 2024, $272 million was available under these facilities.

CREDIT RATING RATIONALE
Stella-Jones' credit rating reflects its top-tier position within its key product categories across North America. The utility poles and railway ties businesses are subject to relatively high barriers to entry, primarily because of the requirements for meaningful scale to develop and maintain key supplier and customer relationships as well as necessary expertise in logistics to ensure timely and cost-competitive product delivery. Sales within the Company's utility poles and railway ties product categories are largely driven by ongoing maintenance requirements of client infrastructure. Furthermore, the contractual arrangements with the Class 1 railroads and the utilities are long term in nature, and clients are not likely to move to smaller competitors that lack extensive manufacturing networks or that are not able to finance and hold large inventories required to service their needs. These barriers to entry help to limit the Company's competition, despite the lack of expensive technological equipment or specialty facilities necessary for the treatment process or distribution of goods.

Company operations depend on the availability of an adequate supply of quality raw materials on a timely basis and, as such, Stella-Jones is exposed to price, quality, and availability risks associated with raw material purchases. Despite timing lags, gross margins have been relatively stable and have shown little commodity price volatility largely due to the cost-pass through features embedded into their contractual arrangements. This earnings stability demonstrates the Company's ability to work with its clients to manage this underlying commodity exposure actively and effectively.

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.

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

(B) Weighting of FRA Factors 
In the analysis of Stella-Jones, the relative weighting of the FRA factors listed in the methodology was approximately equal.

(C) Weighting of the BRA and the FRA 
In the analysis of Stella-Jones, 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 Mining and Forest Products Industries (June 27, 2024), https://dbrs.morningstar.com/research/435122
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781

Morningstar DBRS credit ratings may use of 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 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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