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

DBRS Limited (DBRS Morningstar) changed the trend on 407 International Inc.’s (407 or the Company) ratings to Stable from Negative 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 is mainly supported by the satisfactory traffic volume recovery from the negative impact of the Coronavirus Disease (COVID-19) pandemic as a result of the easing or removal of all pandemic-related restrictions.

The Company reported 1,622.3 million vehicle kilometers travelled (VKT) in the first nine months of 2022, representing a 38% growth on a year-over-year (YOY) basis or approximately 79% of the 2019 level. Revenues in the first nine months of 2022 reached $964.7 million, a growth of 35% YOY and approximately 86% of the 2019 level, better than expected. Of note, the monthly VKTs have been around 85% of their respective pre-pandemic levels since June 2022, with the only exception being September 2022, which reported a monthly VKT at 92% of the 2019 level, mainly attributable to back-to-school travel and further release of pent-up travel demand.

For the full year 2022, DBRS Morningstar currently expects 407’s revenue and EBITDA to reach approximately 87% and 85% of the 2019 levels, respectively. DBRS Morningstar notes that, during the 2008 recession, 407’s traffic volume, as measured by VKT, only dropped 1.7%, which was fully recovered within one year. As such, despite the ongoing macroeconomic conditions and the Company’s temporarily constrained ability to raise tolls, DBRS Morningstar believes its base-case revenue assumption for full year 2023, as discussed in its press release published on June 16, 2022, remains achievable.

The Company’s liquidity status remains healthy. A total of $381 million in operating cash flow was generated during the first nine months of 2022, half of which was realized during Q3. By the end of this year, total non-restricted cash is expected to reach approximately $350 million, and the $800 million credit facility is expected to stay undrawn.

The Company still intends to maintain the senior debt service coverage ratio (DSCR), including shadow amortization, above 1.7 times (x) and the senior and junior cash interest coverage ratios (ICR), net of cash income taxes, at 2.0x, which represent the thresholds that DBRS Morningstar considers suitable for the current rating levels. DBRS Morningstar expects the senior DSCR with shadow amortization and the senior and junior ICR will rise above these thresholds in 2022. Assuming no additional indebtedness and assuming the Company will increase toll rates again only if there is a net financial benefit of doing so after taking into account the potential schedule 22 payment, DBRS Morningstar expects these ratios to gradually improve in 2023 and onward as more traffic returns.

The recent VKT pattern seems to suggest the traffic recovery has somewhat plateaued, which could be explained by the ongoing effect of the work-from-home flexibility provided by employers along with any negative impact of the tightened monetary policy on economic activities. While not expected, if the impact of a potential future recession were more pronounced or protracted than the recession in 2008, full traffic recovery could be further delayed and the ratings may again be pressured.

While DBRS Morningstar expects the ratings to be supported by its base-case forecast and continue to be protected by the rating affirmation test, negative rating pressure may result from a marked deterioration in its base-case traffic outlook, insufficient liquidity, or a leverage increase faster than what can be justified by sustainable traffic levels. A rating upgrade is unlikely.

ESG CONSIDERATIONS
There were no Environmental/Social/Governance 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/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

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

The principal methodology is Global Methodology for Rating Public-Private Partnerships (August 30, 2022, https://www.dbrsmorningstar.com/research/402155/global-methodology-for-rating-public-private-partnerships), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223/interplay-of-global-corporate-finance-rating-methodologies-when-analyzing-corporate-finance-transactions.

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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