DBRS Morningstar Changes Trend on Transcontinental Inc. to Negative, Confirms Issuer Rating at BBB (low)

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating of Transcontinental Inc. (Transcontinental or the Company) at BBB (low) and changed the trend on the rating to Negative from Stable. The rating confirmation reflects the significant benefits of diversification that the Company has experienced with the Packaging segment growing quickly to become an estimated 55% of consolidated F2020 revenue (up from approximately 2% in F2014), which has enabled the Company to pivot quickly to meet rapidly changing market demands. The trend change reflects DBRS Morningstar’s concerns that Transcontinental’s near-to-medium term earnings profile will be negatively affected by the Coronavirus Disease (COVID-19) pandemic’s impact on the structural trajectory of the Printing segment. As such, DBRS Morningstar is concerned that the business risk profile and corresponding key credit metrics could deteriorate beyond the level considered appropriate for the current rating category.

On February 20, 2020, DBRS Morningstar confirmed Transcontinental’s Issuer Rating at BBB (low) with a Stable trend. The rating confirmation reflected the strong operating performance in the Packaging segment, while acknowledging softer-than-expected performance in the Printing segment during F2019 and a slightly slower-than-expected pace of deleveraging following the Coveris acquisition.

At that time, DBRS Morningstar forecast F2020 EBITDA to be between $440 million to $460 million and for gross leverage to move meaningfully towards 2.0 times (x) in F2021. DBRS Morningstar’s outlook on Transcontinental’s earnings has since weakened as a result of the coronavirus pandemic and its related macroeconomic effects on the Company’s individual operating segments.

While the Company has posted better-than-expected performance in the Packaging segment year-to-date, DBRS Morningstar believes that the coronavirus pandemic has accelerated the migration to digital advertising mediums away from print in certain product categories. This trend is expected to negatively affect the Printing segment and pressure consolidated F2020 revenue results to below what had initially been expected for the year. In response to the top-line pressure in F2020, the Company has implemented aggressive cost-cutting measures in the Printing segment, reduced executive pay, and benefitted from better-than-expected results in the Packaging segment, which is expected to result in EBITDA from ongoing operations to be within approximately 10% of the low end of DBRS Morningstar’s initial F2020 EBITDA forecast. DBRS Morningstar’s revised F2020 EBITDA outlook is between $420 million and $440 million. However, a greater degree of uncertainty regarding the near-term outlook exists given the challenging operating environment and headwinds in certain verticals within the Printing segment.

The decline in operating income is expected to have a moderately negative impact on cash flow; as such, key credit metrics are forecast to weaken slightly compared with DBRS Morningstar’s initial F2020 outlook. DBRS Morningstar expects Transcontinental to generate meaningful free cash flow that it may use to continue to reduce debt in the second half of F2020 while maintaining its current dividend commitment. Capex will likely be modestly lower, but not so much that it should create a detrimental impact on the Company’s ability to execute on its long term growth strategy in the Packaging segment or negatively impact the market position of the Printing segment.

Looking ahead, a change of the trend to Stable would reflect a stabilization and subsequent expectation of a recovery in operating income in addition to continued debt reduction so that gross leverage moves into the 2.0x to 2.5x range over the next 12 months and with the expectation that it will be approximately 2.0x over the next 24 months.

Conversely, should operating performance remain suppressed and/or leverage appear to remain structurally in the 2.50x to 3.0x range, a negative rating action could result.

Transcontinental’s rating reflects the Company’s continued strong market position in the print industry, attractive outlook in the Packaging segment, diversified customer base and product offering, and strong free cash flow generating capacity. The rating also continues to consider the structural shift from print to digital media and the risks associated with growth through acquisition.

The primary methodologies are applied on a percent of revenue basis.

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 Printing Industry (March 2020), Rating Companies in the Industrial Products Industry (February 2020), and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Relationships (November 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.

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

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