Morningstar DBRS Assigns Issuer Rating of BB (low) With Stable Trend to Top Aces Inc.

DBRS Limited (Morningstar DBRS) assigned an Issuer Rating of BB (low) with a Stable trend to Top Aces Inc. (Top Aces or the Company). Concurrently, Morningstar DBRS assigned a provisional credit rating of (P) B (high) to the Company's proposed Senior Unsecured Notes (the Proposed Notes), based on a Recovery Rating of RR5. 

KEY CREDIT RATING CONSIDERATIONS
The credit ratings are supported by Top Aces' solid market position in the niche markets of Adverse Air (ADAIR) and Close Air Support (CAS) combat training services for armed forces mainly in Canada, Europe, and the United States, contracted revenue streams, strong safety record, technological capabilities, favourable industry tailwinds, and relatively conservative financial management practices. The credit ratings also reflect the considerable spending requirements related to fleet maintenance and contract growth, risks associated with customer concentration, as well as uncertainties around existing contract renewals, and future contract growth.

Top Aces is proposing to issue approximately $175 million of senior unsecured notes (the Proposed Notes). The proceeds of the issuance will be used to repay amounts related to the Company's existing debt obligations. The Proposed Notes will be guaranteed by all material subsidiaries of the Company. The Proposed Notes will be unsecured obligations ranking equal with all existing and future unsecured indebtedness of Top Aces but will effectively be subordinated to any secured indebtedness of the Company. As part of the Proposed Notes issuance, the Company will also put in place a new $175 million Secured Revolving Credit Facility (the Secured Revolver). Credit metrics are not expected to materially change immediately after the Proposed Notes issuance. The Recovery Rating of RR5 on the Proposed Notes assumes the Secured Revolver is fully drawn and reflects the Secured Revolver's first-lien position.

CREDIT RATING DRIVERS
Morningstar DBRS could take a positive credit rating action should Top Aces materially strengthen its business risk profile, primarily through increasing its size and customer diversification, without necessarily requiring an improvement in key credit metrics to do so. Conversely, should key credit metrics materially deteriorate in aggregate for a sustained period (i.e., debt-to-EBITDA increase toward 4.5 times (x)) because of weaker-than-expected operating performance and/or more aggressive financial management, the credit ratings could be pressured. That said, weaker-than-expected operating performance for a sustained period, resulting in a more permanent shift in the Company's business risk profile, could also result in the requirement to maintain stronger credit metrics to support the same credit rating.

EARNINGS OUTLOOK
Morningstar DBRS anticipates Top Aces' earnings profile will strengthen within the current credit rating category, benefitting from contract growth, including services related to supporting Ukraine over the near term and ADAIR training services in Europe and the U.S. over the more medium term. Revenue growth in 2024 was primarily driven by the full-year benefits from an expanded ADAIR and CAS contract with the Royal Canadian Air Force that was signed in 2023, the full-year contributions from the Company's inaugural ADAIR contract in the United States using Lockheed Martin F-16s (F-16) at the Luke and Eglin Air Force bases, as well as contracts related to F-16 maintenance training and support for Ukraine. Revenue growth in 2025 should benefit primarily from work to support Ukraine and expanded ADAIR and CAS services in the U.S. and Europe. Looking past 2025, Morningstar DBRS expects the Company's revenue growth to be primarily driven by additional ADAIR contracts in Europe and the U.S., benefitting from favourable industry tailwinds for ADAIR services considering their cost effectiveness and the F-35 adoption, evolved training requirements, and pilot shortages of Western militaries. This growth should more than offset a decline in Ukraine-related revenues as they potentially start to roll off in 2026 and 2027. We expect a notable expansion in EBITDA margins in 2025 and 2026, aided by operating leverage gains and relatively stronger margin contribution from new contracts. As such, Morningstar DBRS forecasts EBITDA to continue to see solid growth for the full-year 2024, as well as 2025 and 2026.

FINANCIAL OUTLOOK
Despite the growth in earnings, Morningstar DBRS expect Top Aces' financial profile to remain relatively stable over the near term considering the Company's considerable capital expenditure (capex) requirements for fleet maintenance and to compete for future contracts, which will require incremental debt. Over the more medium term, Morningstar DBRS believes Top Aces' financial profile should improve as the growth in earnings would allow the Company to increasingly self-fund capex requirements. Morningstar DBRS forecasts cash flow from operations (before changes in working capital and principal lease payments) will continue to grow in line with earnings. Considering significant growth and maintenance capex outlays for the full-year 2024, as well as in 2025 and 2026, Morningstar DBRS forecasts the Company to remain in a free-cash-flow deficit position after changes in working capital and principal lease payments, but be in a positive position not accounting for growth capex. Morningstar DBRS anticipates that the Company will fund this deficit with incremental debt. As such, Morningstar DBRS expects leverage to remain relatively stable in 2025 (i.e., debt-to-EBITDA of approximately 3.25x) and decline thereafter.

CREDIT RATING RATIONALE
Comprehensive Business Risk Assessment (CBRA): Top Ace's CBRA of BH reflects the Company's solid market position in its niche markets, contracted revenues streams, strong safety record, technological capabilities, and favorable industry tailwinds. The CBRA also reflects the considerable spending requirements related to fleet maintenance and contract growth, risks associated with customer concentration, as well as uncertainties around existing contract renewals and future contract growth.

Comprehensive Financial Risk Assessment (CFRA): Top Aces' CFRA of BBBL reflects the Company's relatively conservative financial management practices (i.e., debt-to-EBTIDA of approximately 3.25x in 2025).

Intrinsic Assessment (IA): The IA of BBL is within the Intrinsic Assessment Range and is based on the CBRA and CFRA, also taking into consideration peer comparisons, among other factors.

Additional Considerations: The credit ratings include no further negative or positive adjustments resulting from additional considerations.

Recovery Rating: The Recovery Rating of RR5 on the Senior Unsecured Notes assumes a fully drawn secured revolver and reflects the secured revolver's first-lien position.

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) https://dbrs.morningstar.com/research/437781.

Further details on the Issuer's Intrinsic Assessment can be found at https://dbrs.morningstar.com/research/449317.

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

Morningstar DBRS applied the following principal methodology:

Global Methodology for Rating Companies in Services Industries (February 3, 2025) https://dbrs.morningstar.com/research/447184

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (February 3, 2025) https://dbrs.morningstar.com/research/447186 which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodologies have 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

Morningstar DBRS Global Corporate Criteria (February 3, 2025)
https://dbrs.morningstar.com/research/447186

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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