DBRS Morningstar Confirms Ratings on Kruger Packaging Holdings L.P. at BB (high) with Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Senior Unsecured Notes rating of Kruger Packaging Holdings L.P. (KPH or the Company) at BB (high). DBRS Morningstar also confirmed the recovery rating of RR3 on the Senior Unsecured Notes. The trends are Stable. The ratings confirmation reflects KPH’s performance in the last 12 months, which was broadly consistent with DBRS Morningstar’s expectations when we initially assigned the ratings in May 2019 as well as DBRS Morningstar’s view that the Company is adequately prepared to face the Coronavirus Disease (COVID-19)-related disruptions in its supply chain and end markets. The Stable trends reflect DBRS Morningstar’s expectation that KPH will continue operating its business in an efficient manner while keeping leverage commensurate with the ratings, such as adjusted debt-to-EBITDA below 2.0 times and adjusted cash flow-to-debt above 40%, levels that are strong for the ratings, despite the currently challenging environment.

The ratings also take into account KPH’s position in the less volatile paper packaging industry when compared with other forest product subsectors, its cost-effective mills, and the unique properties of some of its products that give the Company a competitive advantage. The conservative balance sheet and low leverage for the rating category are also supportive of the fact that they should give KPH some downside protection. The involvement of KPH’s end customers in sectors such as food, beverage, and other nondurable goods, which are often considered nondiscretionary in nature and thus essential during the coronavirus pandemic, are also supportive of the ratings. Finally, DBRS Morningstar believes that KPH will take necessary measures, such as the deferral of nonessential capital projects and distributions to unitholders, until such time as there will be more clarity around the economic outlook. However, the ratings are constrained by the Company’s niche position and lack of diversification in the broader paper and forest products industry, its low (albeit increasing) forward integration into its corrugated box plants, its exposure to volatile input costs, and the overall underlying volatility of the forest products industry.

Since the rebuild of its Trois-Rivières, Québec, newsprint machine into a containerboard machine that was completed in 2017, the Company is well positioned to produce high-strength light-weight recycled linerboard, which, due to its properties, provides a competitive advantage compared with the traditional containerboard offered by other North American manufacturers. KPH also operates a smaller white top linerboard and paperboard facility in Montréal, as well as two corrugated box plants in Québec and Ontario. Today, the Company’s forward integration is low when compared with some of its major peers, with about 35% of its containerboard production being used as an input into its two corrugated box plants (including trades). Increased forward integration would help further improve margins and create a more stable demand for its linerboard products. In 2019, the Company generated about 80% and 86% of its revenues and EBITDA respectively from its packaging activities.

KPH also operates two pulp and paper facilities in Trois-Rivières that produce Bleached-Thermo-Mechanical-Pulp (BTMP) and uncoated groundwood paper. While BTMP production is almost exclusively sold to Kruger Inc.’s Specialty Paper division, uncoated groundwood paper is sold to third parties, mostly in the newsprint and publishing industry, and to paper converters. The North American demand for newsprint has been in secular decline for many years now, but the Company has appropriately scaled down its operations in order to preserve its profitability. The pulp and paper operations generated about 20% and 14% of revenues and EBITDA, respectively, in 2019, a proportion that is expected to decline further.

Going forward, DBRS Morningstar expects KPH to continue to benefit from its position in the containerboard market, improve its integration, and manage its financial policy in a manner that is commensurate with the current ratings. A deterioration in credit metrics caused by a change in financial policy and/or difficulties in its end markets, caused by more negative coronavirus-related disruptions for example, could lead the ratings to be downgraded. On the other hand, continued strong credit metrics, together with significant improvements in the Company’s business profile, could lead to a positive rating action.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodologies are Rating Companies in the Forest Products Industry (March 19, 2020), DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 22, 2020), DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers (August 22, 2019), and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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@dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

DBRS Morningstar will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrsmorningstar.com.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577