DBRS Morningstar Upgrades CanWel Building Materials Group Ltd.’s Ratings to B (high) from B; Trends Remain Stable

DBRS Limited (DBRS Morningstar) upgraded CanWel Building Materials Group Ltd.’s (CanWel or the Company) Issuer Rating and Senior Unsecured Notes (the Notes) rating to B (high) from B and confirmed the recovery rating for the Notes at RR4. All trends remain Stable. The rating upgrades reflect further strengthening of CanWel’s credit risk profile because of (1) continued momentum in CanWel’s earnings and operating cash flows during the fourth quarter ended December 31, 2020 (Q4 2020), and Q1 2021, supported by a resilient demand for home renovation products even during the usually quieter winter season and strong pricing for construction material; and (2) strengthening of CanWel’s financial profile through an equity offering of up to $86.25 million that has further accelerated the rating upgrades. The Stable trends take into account the cyclicality of the home improvement retail industry and the possible moderation in earnings over the near to medium term from the current surge levels. The rating upgrades are further supported by DBRS Morningstar’s view that, while there is still considerable uncertainty around the economic outlook, home renovation and remodel demand may continue to offset any impact on new construction activities and support a relatively higher earnings level even during this period of uncertainty. 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 in the significant cyclicality and seasonality associated with the building materials industry, the intense competition, and the Company’s high dividend payouts.

On December 18, 2020, DBRS Morningstar confirmed CanWel’s ratings at B and changed the trend on the ratings to Stable from Negative, reflecting its view that, while considerable uncertainty related to the evolution of the Coronavirus Disease (COVID-19) pandemic and its 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. DBRS Morningstar also noted that 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 5.0 times (x) (at low inventory levels) and approximately 6.0x (at peak inventory levels) on a normalized basis, a further positive rating action could occur.

Since then, CanWel has continued to report significantly stronger-than-expected operating results as net sales increased 37% year over year (YOY) to just above $400 million in Q4 2020 and more than 21% for the full year 2020 to $1.61 billion. Additionally, as per the limited financial information released by CanWel on April 19, 2021, sales have continued to trend upward in 2021 and increased materially by 59% YOY to $520 million during Q1 2021, reflecting both volume and price increases because of heightened demand for the Company’s products. EBITDA margins have also benefitted from the surge in sales and increased to 8.9% for F2020 from 6.5% in F2019 because of operating leverage gains and increasing construction material pricing. Consequently, EBITDA grew 66% YOY to $143 million in 2020 and by an exceptional 253% YOY to $60 million in Q1 2021.

In terms of financial profile, CanWel used its 2020 cash flow from operations of $130 million, combined with cash flows from working capital changes of $34 million and net of operating lease payments of $24 million, to reduce the Company’s revolving credit facility by $90 million and for dividend payments of $42 million as capital expenditures remained low at $3 million. As such, CanWel’s key credit metrics improved meaningfully YOY, with debt-to-EBITDA decreasing to 2.5x at the end of 2020 from 5.1x at the end of 2019. The limited Q1 2021 financial information released by CanWel on April 19, 2021, does not include detailed balance sheet or cash flow information.

The rating upgrades also take into account CanWel’s April 21, 2021, announcement that the Company will raise up to $86.25 million by way of a bought deal equity offering (the Offering). The net proceeds of the Offering will initially be used to reduce draws on the Company's credit facility, which would further strengthen CanWel’s financial position. That said, DBRS Morningstar notes that the Company has undertaken a series of acquisitions in the past and may use the additional funds for future acquisitions and/or other growth investments, which DBRS Morningstar has not currently factored into its earnings forecasts.

Looking ahead, DBRS Morningstar expects the impacts of the coronavirus pandemic (such as social distancing and reduced travel) to remain prevalent in the near term, especially in Canada, which should continue to provide a positive secular tailwind for the home improvement sector through the peak construction season in 2021. DBRS Morningstar believes earnings will moderate beyond 2021 but still remain above prepandemic levels as a normalization in demand for home improvement activities is offset by a broad resumption in new construction activities. In terms of the Company’s financial profile, DBRS Morningstar forecasts CanWel’s debt-to-EBITDA ratio in F2021 and F2022 to remain between 3.0x to 4.0x on a normalized basis as earnings moderate and the Company uses debt, along with cash flow from operations, to fund growth investments and shareholder returns, levels that are considered comfortable for the B (high) rating category. Should CanWel’s credit profile deteriorate as a result of materially weaker-than-expected operating performance and/or more aggressive financial management, including any highly leveraged acquisition(s), the ratings could be pressured.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodologies are Rating Companies in the Merchandising Industry (July 30, 2020; https://www.dbrsmorningstar.com/research/364692), Rating Companies in the Forest Products Industry including Appendix I – Timberland Operators (March 16, 2021; https://www.dbrsmorningstar.com/research/375290), and DBRS Morningstar Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (August 24, 2020; https://www.dbrsmorningstar.com/research/366063), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

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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