Morningstar DBRS Confirms Credit Ratings on Federated Co-operatives Limited at BBB (high) with Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating and the rating on the Senior Unsecured Notes of Federated Co-operatives Limited (FCL or the Company) at BBB (high) with Stable trends.

KEY CREDIT RATING CONSIDERATIONS
Although FCL's operating performance in F2024 (fiscal year ended October 31, 2024) is likely to be weaker than expected, the rating confirmations continue to acknowledge FCL's strong financial profile, based on its robust cash flow generating capacity and exceptionally low financial leverage, that continues to support the overall credit profile. The Stable trends reflect Morningstar DBRS' expectations that FCL's earnings profile will remain appropriate for the credit rating category, predicated on the staple nature of the products offered, the integrated nature of the Co-operative Retailing System (CRS) network, and its ability to navigate through variance in crude oil and fuel prices, refiners' margins, and the refinery's capacity utilization.

On November 17, 2023, Morningstar DBRS confirmed FCL's ratings at BBB (high) with Stable trends. At that time, Morningstar DBRS stated that operating margins are likely to be pressured in F2024 due to inflationary pressures and moderation in refinery margins and expected EBITDA to decline toward $900 million from elevated levels of over $1 billion in F2023. Morningstar DBRS notes that F2024 operating results could be more severely affected due to higher-than-expected fall in refinery margins, unforeseen events during the year such as the cybersecurity incident in Q3 F2024, and the largest turnaround in FCL history, that resulted in more downtime than in any of the past few years. However, this continues to be offset by FCL's strong financial profile and Morningstar DBRS' expectations of improvement in operating results in F2025 and F2026.

CREDIT RATING DRIVERS
Should the Company's key credit metrics weaken materially (i.e., debt-to-EBITDA increases above 1.75 times (x)) due to a sustained period of weaker-than-expected operating performance and/or more aggressive financial management, a negative rating action could occur. Conversely, a positive rating action would require a very meaningful improvement in the Company's business risk profile while maintaining the current relatively strong key credit metrics.

EARNINGS OUTLOOK
Looking ahead, Morningstar DBRS expects FCL's operating results to improve marginally from F2024 levels and earnings profile to remain relatively stable on a through-the-cycle basis in the medium term. Morningstar DBRS expects fuel volumes to continue to grow in the low single digits in 2025 and 2026 and the Energy segment to benefit from full-year throughput from the refinery operations. Morningstar DBRS anticipates that this will be partially offset by ongoing demand moderation and inflationary headwinds in the nonenergy segments, including the Food and Home and Building Solutions segment. EBITDA margins for the Energy segment normalized due to narrowing crack spreads in F2024, especially compared with strong F2023 levels, and are expected to remain susceptible to material variances in crude oil and fuel prices. This, coupled with relatively higher input costs and FCL's policy aligned towards supporting its member community, particularly during periods of economic uncertainty, is likely to pressure operating margins further, at least in the near term before marginal improvement in F2026. As such, Morningstar DBRS expects FCL's EBITDA to remain below $850 million in F2025 and be in a range of between $850 million to $900 million in F2026, compared with around $800 million in F2024.

FINANCIAL OUTLOOK
Despite operating pressure, Morningstar DBRS expects FCL's financial profile to remain exceptionally strong and continue to underpin the overall rating category, primarily driven by the Company's low level of debt. Cash flow from operations (before any working capital changes) is expected to track operating income and remain between $750 million to $800 million range in F2025 and F2026 versus Morningstar DBRS estimate of approximately $700 million in F2024. Capital expenditure is expected to remain relatively higher at approximately $400 million to $450 million annually as the Company continues to invest in growth and capital projects. Morningstar DBRS notes that while there is the possibility that FCL may undertake debt-funded energy transition projects, these haven't been incorporated into the current forecast. Morningstar DBRS expects the Company to continue to generate sufficient cash flow (after distributions but before changes in working capital) to invest in growth and/or grow its cash balance for potential future investments. The current forecast assumes a limited debt increase in the near term, primarily for working capital or short-term business needs. As such, FCL's debt-to-EBITDA is expected to remain below 1.25x over the forecast period, well below levels acceptable for the current ratings.

CREDIT RATING RATIONALE
FCL's ratings continue to be supported by the strong brand and market position of the CRS, its co-operative structure, and the high barriers to entry of the refinery business. The ratings also consider the relatively medium- to long-term risk from the electric vehicle transition, cyclicality of refinery operations, geographic concentration and competition, and other associated environmental and regulatory risks

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Environmental (E) Factors
Morningstar DBRS considered Carbon and Greenhouse gas costs as a relevant environmental factor. This factor is relevant because compliance with ever-increasing environmental regulations and standards limits the growth potential and adds costs for all oil and gas companies, including FCL.

Social (S) Factors
There were no Social factors that had a significant or relevant effect on the credit analysis.

Governance (G) Factors
There were no 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) https://dbrs.morningstar.com/research/437781

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)

A) Weighting of BRA Factors

In the analysis of FCL, the relative weighing of the BRA factors listed in the Merchandising methodology was relatively equal. For the Oil & Gas methodology section, the BRA factors were considered in the order of importance contemplated in the methodology.

B) Weighting of FRA Factors 
In the analysis of FCL, the relative weighting of the FRA factors listed in the Merchandising methodology was approximately equal. For the Oil & Gas methodology section, the FRA factors were considered in the order of importance contemplated in the methodology.

C) Weighting of the BRA and the FRA 
In the analysis of FCL, 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 Merchandising Industry (August 14, 2024) https://dbrs.morningstar.com/research/437891

Global Methodology for Rating Companies in the Oil and Gas, Oilfield Services, Pipeline, and Midstream Energy Industries (August 12, 2024) https://dbrs.morningstar.com/research/437739

In assessing the business risk of FCL, Morningstar DBRS accounts for Global Methodology for Rating Companies in the Merchandising Industry (the Merchandising Methodology) and Global Methodology for Rating Companies in the Oil and Gas, Oilfield Services, Pipeline, and Midstream Energy Industries (the O&G Methodology) on roughly equal basis. Morningstar DBRS uses the Merchandising Methodology to cover the integrated nature of the Company's wholesaling business and the O&G Methodology to review the risks related to FCL's refinery operations. Morningstar DBRS also considers the income derived from each of these areas, the interrelationship between them, and any diversification benefits.

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 ESG 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 dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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