DBRS Morningstar Changes Trend on 407 International Inc. to Negative from Stable, Confirms Ratings

DBRS Limited (DBRS Morningstar) changed the trend on 407 International Inc.’s (407 or the Company) ratings to Negative from Stable and confirmed its Issuer Rating and Senior Bonds rating at “A,” Junior Bonds rating at A (low), and Subordinated Bonds rating at BBB. The trend change mainly stems from a slower-than-expected recovery in projected traffic volume through 2021, as a result of the impact of the Coronavirus Disease (COVID-19), and the heightened uncertainty about the speed of financial recovery, which partly depends on whether or not the Company can receive meaningful relief with respect to the coronavirus-induced Schedule 22 payments.

Traffic volume continued to recover in August and September 2020 with monthly vehicle kilometres traveled (VKT) at 56% and 62% of the corresponding monthly levels in 2019, respectively. However, driven by a series of tightening measures by the governments in light of the second wave, the traffic recovery seemed to have stalled, with monthly VKTs in October 2020 at approximately 53% of the 2019 level and VKTs in November 2020 so far showing no sign of further improvement. Total year-to-date VKTs as of the end of October 2020 were about 55% of the 2019 level.

Compared with a few months ago, there is better visibility into efficacy and timing for a coronavirus vaccine, but the rollout remains unclear. DBRS Morningstar currently forecasts that 407’s total 2020 VKTs will be approximately 44% below the 2019 level, which translates to approximately 39% lower revenue. DBRS Morningstar further assumes that total revenue in 2021 will be approximately 20% lower than that of 2019, followed by a typical year-over-year revenue growth of 8% in both 2022 and 2023 (the DBRS Morningstar Base Case). Under the DBRS Morningstar Base Case, the senior debt service coverage ratio (DSCR), including shadow amortization and the senior and junior interest coverage ratio, will fall below 1.7 times (x) and 2.0x, respectively, in both 2020 and 2021. DBRS Morningstar expects these metrics to revert to levels that are commensurate with the ratings in 2022, assuming no additional leverage through 2021, under the DBRS Morningstar Base Case.

DBRS Morningstar notes that the Company can use the proceeds from debts or equity to pay interest on the Subordinated Bonds without having to meet the senior DSCR threshold of 1.35x. In May 2020, 407 set aside approximately $70 million in borrowed funds, representing subordinated interest payments over 24 months, to pay the subordinated interest if the senior DSCR falls below 1.35x.

Because of the lower-than-expected traffic projection, the coronavirus-induced Schedule 22 payments could become very significant, although DBRS Morningstar understands that the amount payable has not been decided as the Company is seeking relief under the Concession Agreement and the management believes that the likelihood of incurring significant Schedule 22 Payments is low. Should the Schedule 22 payments materialize to a significant level, in addition to available cash balances the Company has the option to use its credit facilities to fund these amounts. As such, the credit could face added pressure to the extent that the Company’s leverage may increase, potentially delaying the recovery of financial metrics.

Despite the lower traffic levels, the Company generated free cash flows (cash flows from operating activities less capital expenditures) of approximately $69 million during the third quarter of 2020 and continue to generate positive cash flow from operation on a monthly basis. In addition to 407’s $800 million in undrawn credit facilities, DBRS Morningstar expects the Company to have sufficient cash to cover all costs, including debt service payments, through 2021 even with no further traffic recovery from the current level through 2021.

As the coronavirus pandemic continues to develop, DBRS Morningstar will monitor 407 closely and will update the analysis if the DBRS Morningstar Base-Case assumptions have materially and negatively changed. The ratings could stabilize if the Company proves able to maintain the DSCR thresholds of 1.7x and 2.0x on a sustainable basis. DBRS Morningstar may take negative rating action if it becomes apparent that the Company will not be able to restore the DSCR thresholds of 1.7x and 2.0x or if 407’s liquidity becomes insufficient. It could also pressure the rating if the Company has to increase leverage for reasons such as significant Schedule 22 payments or dividends before the traffic volume sufficiently recovers,.

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 methodology is Rating Public-Private Partnerships (August 19, 2020), 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.

This rating was initiated at the request of the rated entity.

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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