DBRS Morningstar Changes Trend on CanWel’s Ratings to Stable from Negative, Confirms Ratings at B

DBRS Limited (DBRS Morningstar) changed the trend on CanWel Building Materials Group Ltd.’s (CanWel or the Company) Issuer Rating and Senior Unsecured Notes (the Notes) rating to Stable from Negative and confirmed both ratings at B. DBRS Morningstar also confirmed the Recovery Rating for the Notes at RR4. The trend change reflects DBRS Morningstar’s view that while considerable uncertainty related to the evolution of the Coronavirus Disease (COVID-19) pandemic and the macroeconomic aftereffects remains, CanWel is in a position to navigate the current environment within the context of the B rating category, without the need for meaningfully stringent capital conservative measures. This view is based on CanWel’s significantly stronger-than-expected operating results during the last two quarters, ended September 30, 2020, and June 30, 2020, respectively, which benefitted from a demand surge in the home improvement sector and rising lumber prices, combined with DBRS Morningstar’s expectation that the Company’s go-forward operating results are not likely to be affected beyond what would be acceptable for the current rating category. CanWel’s ratings also continue to be supported by its well-established market position, diversified customer and supplier bases, and relatively high barriers to entry. The ratings also continue to factor the significant cyclicality and seasonality associated with the building materials industry, the intense competition, and the Company’s high dividend payouts.

On June 1, 2020, DBRS Morningstar removed CanWel from Under Review with Negative Implications, downgraded the Company’s ratings from B (high) to B, and changed the trend to Negative. The rating actions reflected DBRS Morningstar’s view at the time that the pandemic and the macroeconomic aftereffects would have a material negative impact on CanWel’s earnings profile and would likely cause key credit metrics to deteriorate beyond a level considered acceptable for the B (high) rating for an extended period. The negative trend also reflected concerns that the Company may not take appropriate capital conserving measures with respect to the Company’s dividend policy and, to a lesser degree, the risk of the Company’s earnings profile further weakening in F2021. At the time, DBRS Morningstar stated that, should EBITDA remain at levels above $70 million in F2020 and F2021, the Company would have the ability to maintain its rating level when combined with an appropriate reduction in dividend outlay such that key credit metrics do not deteriorate beyond a range acceptable for the B rating (i.e., lease-adjusted debt-to-EBITDAR of not above 7.0 times (x) for a sustained period), adjusted for seasonal debt balance fluctuations.

Since then, the home improvement sector benefitted from a unexpected surge in demand, driven in large part by do-it-yourself activity as consumers sheltered in place and embarked on home renovation and remodeling projects. Although the demand for building materials initially fell in the early part of the pandemic, a number of factors, including work-from-home mandates, restrictions on travel, and leisure activities, combined with a low interest rate environment, led to a shift in consumer spending toward home improvement. Similarly, housing starts have trended upwards after falling by over 12% in the second quarter of 2020. This elevated demand for construction materials, specifically lumber, combined with production curtailments by suppliers due to coronavirus-related lockdowns resulted in an unprecedented surge in lumber prices, which peaked during the third quarter of 2020 before returning to relatively stable levels by early November. DBRS Morningstar notes that the Company’s margins are affected by the relative level of construction materials pricing), as well as the pricing trend as the Company buys and sells inventory.

As such, CanWel reported significantly stronger-than-expected operating results during the last two quarters. Net sales increased 16.4% year over year (YOY) to just above $1.2 billion during the nine months ended September 30, 2020 (9M 2020) due to the factors mentioned above, and, to a lesser extent, contributions from Lignum Forest Products LLP (Lignum), acquired in April 2019. EBITDA margins increased substantially to 8.8% during the 9M 2020 from 6.5% during the 9M 2019, benefitting from an unprecedented spike in construction material pricing during the second and third quarter, cost reduction measures, and due to the adoption of IFRS 16 standards. Consequently, LTM EBITDA for the 9M 2020 grew 38.5% to $125 million as compared with $77 million for the LTM 9M 2019.

CanWel used its cash flow from operations of $96 million during the 9M 2020, combined with cash flows from working capital changes of $36 million, to reduce the Company’s revolving credit facility by $70 million and for dividend payments of $33 million. As such, given the substantially higher EBITDA combined with a lower YOY utilization of the Company’s revolving loan facility resulted in a meaningful improvement in CanWel’s key credit metrics YOY (i.e., debt-to-EBITDA of 3.0x at the end of September 2020 versus 5.6x at the end of September 2019, and 6.9x at the end of June 2019). Although CanWel has not taken meaningful capital conserving measures with respect to its dividend (the Company had only curtailed its dividend to $0.12 per share from $0.14 per share prior to the pandemic), given the stronger-than-expected operating results and cash flows combined with a decrease in leverage, DBRS Morningstar believes the Company has enough financial flexibility within the context of the B rating category at this time.

Looking ahead, considerable uncertainty related to the evolution of this pandemic and the macroeconomic aftereffects remains, and DBRS Morningstar expects sales and margins to come down in 2021 from the surge levels experienced through 2020 as the demand for home improvement activity normalizes. However, DBRS Morningstar expects earnings in 2021, even in the context of increased volatility, to be supportive of the B rating category. Should the Company’s operating performance remain relatively stable through this period, combined with prudent financial management, such that the lease-adjusted debt to EBITDA ratio is sustainable between approximately 6.0x (at peak inventory levels) and approximately 5.0x (at low inventory levels) on a normalized basis, a further positive rating action could occur. Conversely, should CanWel’s credit profile deteriorate as a result of weaker-than-expected operating performance and/or aggressive financial management, including the absence of dividend curtailments when necessitated by pressured operating results, the trend could be changed to Negative.

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 (August 15, 2019), Rating Companies in the Forest Products Industry including Appendix I – Timberland Operators (March 19, 2020), DBRS Morningstar Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (August 24, 2020), and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2, 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.

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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