DBRS Morningstar Confirms Ratings on Federated Co-operatives Limited and Removes Under Review with Negative Implications Status

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Senior Unsecured Notes rating of Federated Co-operatives Limited (FCL or the Company) at BBB (high) with Stable trends. This rating action removes the ratings from Under Review with Negative Implications, where they were placed on April 30, 2020. The rating confirmations and Stable trends reflect DBRS Morningstar's view that, while near term earnings will remain stressed following the Coronavirus Disease (COVID-19) pandemic and resultant macroeconomic aftereffect, the impact on FCL's earnings profile will likely be less severe than initially forecasted when the Company was put Under Review with Negative Implications at the onset of the global pandemic. Furthermore, FCL's financial profile is expected to remain very strong for the current rating category despite stress on operating income, primarily because of very low level of debt and financial flexibility. FCL's current ratings are supported by strong brand and market position of the Co-operative Retailing System (CRS), the co-operative structure and high barrier to entry of the refinery business, while also continuing to consider the single-asset nature of the refinery, the associated environmental and regulatory risks, and intense competition.

DBRS Morningstar forecasts revenue to decrease to $7.6 billion range for the year ended on or around October 31, 2020 (F2020), from $9.2 billion in F2019, primarily driven by the coronavirus containment and mitigation measures, specifically stay-at-home mandates and business shutdowns, which resulted in a dramatic decrease in fuel volume during Q2 and Q3 F2020. That said, DBRS Morningstar expects the Company's earnings profile to weaken moderately but remain supportive of the current rating category over the medium term on a through-the-cycle basis based on the staple nature of the products offered and the integrated nature of the CRS network while continuing to reflect the variance in crude oil and fuel prices, refiners' margins, and capacity utilization of the refinery. While fuel volumes are expected to be materially lower in F2020, DBRS Morningstar expects moderate recovery beginning F2021 based on the stability of Ag segment and commercial transport sector, which have shown early signs of recovery. DBRS Morningstar expects EBITDA margins to decline in the near to medium term, primarily driven by the impact of changes in crude oil and fuel prices and, to a lesser extent, the material decline in F2020 fuel volume following the coronavirus pandemic. As such, DBRS Morningstar expects the Company's EBTIDA to decrease to approximately $700 million in F2020 from $1.4 billion in F2019 (DBRS Morningstar notes that the introduction of quarterly loyalty payments results in approximately $200 million lower EBITDA beginning F2020). While FCL’s earnings should begin to recover starting next year, DBRS Morningstar notes that the earnings could remain challenged to return to recent levels in the near to medium term.

While FCL's credit metrics are expected to weaken in the near term due to the stress on earnings, DBRS Morningstar expects that the Company's financial profile would remain more than acceptable for the current rating, primarily driven by low level of debt and financial flexibility. Cash flow from operations is expected to continue to track operating income. Capex is expected to be moderately lower in F2020 as the majority of the planned turnaround has been delayed until F2021. DBRS Morningstar expects the Company to generate sufficient free cash flow (before changes in working capital but after distributions) to invest in growth, increase cash returns and/or grow the Company’s cash balance for potential future investments. As such, FCL’s credit metrics should remain more than acceptable for the current ratings (i.e., lease-adjusted debt to EBITDA below 1.25 times) over the near to medium term. Given the Company’s business risk profile and current environment surrounding the coronavirus pandemic, a rating upgrade is unlikely at this time. Should the Company’s credit metrics weaken beyond the range on a through-the-cycle basis as a result of weaker-than-expected operating performance and/or more aggressive financial management, the ratings could be pressured.

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 Merchandising Industry (July 30, 2020), Rating Companies in the Oil and Gas and Oilfield Services Industries (August 17, 2020), DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 22, 2020), and DBRS Morningstar Criteria: Rating 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.

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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