DBRS Morningstar Changes Trends on Saputo to Negative From Stable, Confirms Ratings at BBB (high)

DBRS Limited (DBRS Morningstar) changed the trends on Saputo Inc.’s (Saputo or the Company) Issuer Rating and Senior Unsecured Notes rating to Negative from Stable and confirmed the ratings at BBB (high). The Negative trends reflect the Company’s deteriorating operating performance that began in the fourth quarter of F2021 and worsened over the first half of F2022. As Saputo’s most recent performance was meaningfully below DBRS Morningstar’s expectations, the concern is heightened that near-term recovery may be difficult to achieve amid challenging market conditions, including commodity price volatility, inflationary pressure on input costs, labour shortages, and supply chain disruptions.

DBRS Morningstar’s confirmation of Saputo’s ratings on December 8, 2020, was based on the expectation that, through its operating performance and financial management, the Company’s credit metrics would improve to a level more appropriate for the BBB (high) rating category (i.e., lease-adjusted debt-to-EBITDA below 2.75 times (x)) in the medium term, following a delay in its deleveraging strategy caused by the Coronavirus Disease (COVID-19) pandemic. At that time, DBRS Morningstar forecast leverage to improve toward 2.75x in F2022 primarily on account of an anticipated growth in EBITDA, which DBRS Morningstar forecast to be above $1.5 billion in F2022. DBRS Morningstar also commented that a negative rating action could result if operating performance deteriorated beyond its expectations, regardless of capital-conserving measures undertaken by the Company to improve credit metrics through debt reduction.

Saputo’s earnings in the last 12 months (LTM) ended September 30, 2021 (Q2 F2022) were negatively affected by commodity price volatility, input cost inflation, and higher operating costs resulting from labour shortages and supply chain disruptions, which outpaced the benefits of pricing actions undertaken by the Company to address these pressures. Consequently, EBITDA declined to around $1.31 billion in the LTM ended Q2 F2022 from approximately $1.47 billion in F2020 and F2021. Leverage weakened to 3.29x in the LTM ended Q2 F2022, compared with 2.80x in F2021 and 3.06x in F2020, because of the decline in EBITDA and a modest increase in debt, and remained at levels that are high for the current rating category.

DBRS Morningstar believes that these difficult market conditions will continue to pressure Saputo’s operating performance such that F2022 EBITDA will be below that of F2021. DBRS Morningstar is also concerned that EBITDA recovery could be challenged in F2023.This view is based on the expectation that, while the Company has and will continue to take pricing actions to mitigate commodity, inflationary, and operating pressures, this could adversely affect volumes. Furthermore, DBRS Morningstar believes that margins and EBITDA could remain pressured by higher operating costs and operational inefficiencies as a result of sustained labour shortages in some geographies, as well as ongoing supply chain disruptions. Saputo has taken steps to address these challenges, including network optimization initiatives in facilities that have stable access to labour, SKU rationalization, and investments in automation. However, DBRS Morningstar anticipates that these initiatives will be EBITDA accretive only at the end of F2023. The lack of a meaningful recovery in EBITDA will result in near-term credit metrics that persist at levels that are not supportive of the BBB (high) rating category.

Should a meaningful recovery in EBITDA from a combination of margin and/or volume growth not occur in the next one to two quarters, DBRS Morningstar could downgrade the ratings, regardless of capital-conserving measures undertaken by the Company to improve credit metrics through debt reduction. Conversely, if price increases, input and operating cost relief, and efficiency improvements lead to restored growth in EBITDA and consequently recover lease-adjusted debt-to-EBITDA to at least below 2.75x over the next four quarters, the ratings outlook could stabilize. DBRS Morningstar notes that the threshold for Saputo’s credit metrics have become more sensitive to the current macroeconomic environment, as the range of probable outcomes for key variables, including pricing and input and operating costs, have widened.

Saputo’s current ratings continue to be supported by its leading market position, diversification of operations by distribution channel and geography, and strong free cash flow generation. The ratings also continue to reflect the Company’s exposure to volatile commodity prices, the highly competitive industry, and the risk associated with the mature geographies in which Saputo operates, all of which are regulated.

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 Consumer Products Industry (July 26, 2021) and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (May 31, 2021), 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 https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

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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