Morningstar DBRS Confirms Finning International Inc. at BBB (high) and R-2 (high) With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed its Issuer Rating and Senior Debentures and Medium-Term Notes credit rating on Finning International Inc. (Finning or the Company) at BBB (high) and the Company's Commercial Paper credit rating at R-2 (high), all with Stable trends.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations recognize the Company's strong, stable business risk assessment (BRA) as the largest exclusive dealer of Caterpillar Inc. (CAT) equipment, with a global distribution presence and market leadership in its territories. The Company demonstrated resilience in its operating performance and delivered strong free cash flow, notwithstanding some headwinds across its diverse markets. Finning continues to execute its strategic plan to deliver structural improvements across its operations. The Company has delivered meaningful progress on this plan through sustained sales growth and operational cost savings. The Stable trends reflect Morningstar DBRS' expectation that the Company's core markets will remain supportive of earnings and operational cash flows. In the medium term, Finning seems likely to progress toward a moderately stronger credit risk profile, supported by a combination of stable earnings and discipline in capital allocation.

On April 24, 2024, Morningstar DBRS confirmed Finning's credit ratings at BBB (high)/R-2 (high), all with Stable trends. Since then, Finning reported results for the full year ended December 2024 (2024). The Company achieved year-over-year (YOY) gross revenue growth of 6.5% to $11.2 billion, in line with Morningstar DBRS' expectations, driven by a strong revenue growth momentum in Chile (14% YOY) and offset by lower product support revenue growth in Western Canada. Morningstar DBRS calculated that EBITDA declined by 6.6% to $1.2 billion and EBITDA margin contracted by 160 basis points YOY, below Morningstar DBRS' expectations. EBITDA decline resulted from pressure on pricing and a less favourable revenue mix. The moderate decline was partially offset by improved efficiency from the Company's ongoing operational restructuring efforts. Operating cash flow before changes in working capital (as defined by Morningstar DBRS) grew by 5.9% YOY, reflecting the Company's strong earnings to cash conversion. Free cash flow (as defined by Morningstar DBRS) improved to $714 million from a deficit of $80 million in 2023, supported by moderate capital expenditure (capex) net of rental fleet disposals and positive change in working capital. Lease-adjusted gross debt-to-EBITDA remained unchanged at 2.1 times (x), benefitting from a modest deleveraging.

CREDIT RATING DRIVERS
Morningstar DBRS may take a positive credit rating action if Finning maintains its commitments toward deleveraging through a combination of earnings growth and moderate repayment of short-term debt over time, such that the Company maintains a gross debt-to-EBITDA ratio considerably below 2x for a sustained period.

Conversely, and although unlikely given the strength of the current BRA and the Stable trends, Morningstar DBRS may take a negative credit rating action if weaker-than-expected earnings and/or more aggressive financial policies result in weaker credit metrics on a continuous basis (e.g., gross debt-to-EBITDA increases to levels close to 3x).

EARNINGS OUTLOOK
The current operating environment characterized by uncertainty linked to import tariffs in the United States and weaker commodity prices could influence some of Finning's customers to remain cautious on growth spending. That said, the direct exposure to Finning's operational performance is largely mitigated by the Company's strong diversification by customer and geographic presence. Stabilized mining and oil and gas activity in Western Canada is expected to support healthy levels of asset utilization and demand for product support. Public sector investments in infrastructure across Finning's territories are supportive of base demand for equipment sales and/or rentals. The outlook for mining in Chile remains positive on the back of brownfield expansions, while electric power systems and engines continue to show growth, particularly in the UK and Ireland.

Morningstar DBRS expects revenue growth to be relatively flat YOY, supported by South American operations, a strong momentum in used equipment sales, and a recovery in the Canadian product support segment. The revenue growth expectations are challenged by a competitive pricing environment due to improved equipment availability. Furthermore, equipment demand may be slower coming off a high base of strong sales growth in the past three years. Morningstar DBRS anticipates EBITDA margins to remain under pressure in 2025, reflecting a challenging operating environment, offset by Finning's continuous and targeted cost management and efficiency initiatives. In the medium term, revenue and EBITDA are expected to grow at a steady pace on expectations of an increasingly favourable sales mix, supportive trends in copper mining in South America, and easing inflationary pressure across the Company's core markets. The UK's modest contribution is expected to remain under pressure because of a slow rebound in construction projects, partially offset by steady product support and healthy demand for power generation.

FINANCIAL OUTLOOK
Morningstar DBRS expects operational cash flows to trend in line with earnings, reflecting modest changes in interest and tax payments YOY. Gross capex excluding the rental fleet should be in line with 2024 as the Company improves its information systems, sales platforms and other growth projects. Finning looks set to continue to capitalize its rental fleet albeit at a disciplined pace aligned with rental demand signals. A combination of steady operational cash flows and positive net working capital should result in strong positive free cash flow, which is an important countercyclical feature for the Company. Part of the free cash flow is expected to be used for shareholder distributions through the normal course issuer bid. Morningstar DBRS does not expect major changes in indebtedness in the near term. Gross debt-to-EBITDA is expected to remain at around 2x and strengthen above the current credit rating category in the medium term.

CREDIT RATING RATIONALE
Finning's market leadership in dealing heavy equipment across its territories further supports its credit ratings. The Company has a strong franchise as a leading distributer of CAT's industrial equipment. Market acceptance and competitiveness of CAT's products, particularly in construction, energy, and mining, provide an anchor for Finning's operational growth and continuity. Market diversification and a solid distribution network support the growing proportion of recurring aftermarket services earnings. The credit ratings are constrained by financial leverage that has historically been relatively high (i.e., gross debt-to-EBITDA in the 2x to 3x range). If Finning's management remains committed to a stronger balance sheet, the Company's financial risk assessment could improve above current levels in the medium term.

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/452462.

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 ESG 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.

For more information on Morningstar DBRS' policy regarding the solicitation status of credit ratings, please refer to the Credit Ratings Global Policy, which can be found in the Morningstar DBRS Understanding Ratings section of the website: https://dbrs.morningstar.com/understanding-ratings

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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