DBRS Morningstar Changes Trends on Kruger Products L.P.’s Ratings to Negative From Stable, Confirms Issuer Rating at BB and Senior Unsecured Notes Rating at B (high)

DBRS Limited (DBRS Morningstar) changed the trends on Kruger Products L.P.’s (KPLP or the Company) Issuer Rating and Senior Unsecured Notes (the Notes) rating to Negative from Stable and confirmed the Issuer Rating at BB and the Notes rating at B (high). The Recovery Rating on the Notes remains RR6. The Negative trends reflect the significant deterioration in KPLP’s financial performance in H1 2022 (the six months ended June 30, 2022), which was attributable to soaring inflation on input and operating costs and materially below DBRS Morningstar’s expectations. The Negative trends also reflect DBRS Morningstar’s heighted concern that a near-term recovery may be difficult to achieve as the Company could be challenged to continue to pass through price increases to protect gross profit margins without negatively affecting volumes.

On March 25, 2022, DBRS Morningstar confirmed KPLP’s ratings with Stable trends, based on the expectation that, as the TAD Sherbrooke and Sherbrooke Expansion Projects ramped up, the Company’s business risk profile would strengthen, thus driving earnings growth and an improvement in credit metrics in the medium term. At that time, DBRS Morningstar forecast debt-to-EBITDA to improve modestly below 7.0 times (x) from 7.3x in 2021, primarily attributable to the anticipated growth in EBITDA, which DBRS Morningstar projected to be approximately $175 million in 2022. DBRS Morningstar stated then that, should credit metrics deteriorate for a sustained period as a result of weaker-than-expected operating performance and/or more aggressive financial management, the ratings would be pressured.

Since DBRS Morningstar’s last rating action, KPLP has reported its H1 2022 results. In H1 2022, revenue grew by 23% year-over-year to approximately $800 million, attributable to selling price increases and volume recovery and growth in both the Consumer and Away-From-Home segments. As such, in the last 12 months (LTM) ended H1 2022, revenue increased to more than $1.6 billion from less than $1.5 billion in 2021. EBITDA was only $41 million in H1 2022, down 45% from the same period last year. EBITDA was pressured by spiking commodity prices and soaring inflation on natural gas, freight, and packaging, which were significantly worse than DBRS Morningstar’s previous expectations and which outpaced selling price increases. Labour shortages and operational inefficiencies at the Company’s Memphis manufacturing facility also acted as a drag on EBITDA. Consequently, in the LTM ended H1 2022, EBITDA contracted to approximately $120 million, well below the 2021 level of more than $150 million. The material decline in EBITDA coupled with an increase in debt, which was the result of negative free cash flow and the Company’s expansionary capital initiatives including the TAD Sherbrooke and Sherbrooke Expansions projects, resulted in debt-to-EBITDA deteriorating to more than 10.0x in the LTM ended H1 2022 from 7.3x in 2021.

DBRS Morningstar anticipates inflationary cost pressures to persist in H2 2022, which KPLP will address through further selling price increases and cost-saving and efficiency-improving initiatives, including its Operational Excellence Program. That said, DBRS Morningstar believes that the Company could be challenged to continue to pass through price increases to protect gross profit margins without negatively affecting volumes. Additionally, KPLP’s near-term operating performance will remain pressured should operational inefficiencies at its Memphis manufacturing facility persist. The lack of a meaningful recovery in EBITDA will result in a credit risk profile that is no longer commensurate with the current BB rating category.

Should a meaningful recovery in EBITDA from a combination of margin and/or volume growth not occur in the next 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 cost-saving and efficiency-improving initiatives lead to restored EBITDA growth and consequently to a recovery in key credit metrics over the next four quarters, the ratings outlook could stabilize.

KPLP’s current ratings continue to be supported by its strong brands and leading market position, stable demand, and significant barriers to entry. The current ratings also continue to reflect intense competition, volatile input costs, and product/market concentration.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance (ESG) factors that had a significant or relevant effect on the credit analysis.

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/396929.

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

The principal methodologies are Rating Companies in the Consumer Products Industry (July 26, 2021; https://www.dbrsmorningstar.com/research/382072); DBRS Morningstar Criteria: Guarantees and Other Forms of Support (April 4, 2022; https://www.dbrsmorningstar.com/research/394683/dbrs-morningstar-criteria-guarantees-and-other-forms-of-support ); and DBRS Morningstar Global Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (September 1, 2022; https://www.dbrsmorningstar.com/research/402218/dbrs-morningstar-global-criteria-recovery-ratings-for-non-investment-grade-corporate-issuers), 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 (May 17, 2022; https://www.dbrsmorningstar.com/research/396929).

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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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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