DBRS Morningstar Confirms Transcontinental Inc.’s Ratings at BBB (low)

DBRS Limited (DBRS Morningstar) confirmed Transcontinental Inc.’s (Transcontinental or the Company) Issuer Rating and Senior Unsecured Debt rating at BBB (low). All trends are Stable. The confirmations reflect DBRS Morningstar's expectation of a relatively stable credit risk profile in F2023 (year-ending October 29, 2023) reflecting steady operating performance and moderate deleveraging. The Stable trends reflect DBRS Morningstar's expectation that the Company’s deleveraging and diversification will continue to support the current rating category. The ratings consider the significant benefits of diversification that the Company has experienced with the Packaging segment, which now represents 56% of consolidated F2022 revenue (up from approximately 11% in F2016). The ratings reflect Transcontinental’s continued strong market position in the print industry, attractive outlook in the Packaging segment, diversified customer base and product offering, and strong free cash flow (FCF)-generating capacity. The ratings also continue to consider the structural shift to digital media from print and the risks associated with growth through acquisition.

Transcontinental’s reported revenue increased 11.8% year over year (YOY) in F2022 to $2.96 billion despite the inclusion of a 53rd week in F2021 results. Revenue growth was driven by price increases, implemented to offset inflationary cost pressure, and acquisitions made during the year, which contributed to positive volume growth in the Packaging and Print segments. DBRS Morningstar-calculated F2022 EBITDA declined to $447 million versus $465 million in F2021, as the Company continued to feel inflationary pressure on input costs, including higher resin prices (and the lag of passing on related cost), acquisition-related expenses, the end of the federal wage subsidies that the Company received in F2021, and pandemic-related production capacity challenges in the Packaging and Print segments early in the year. The decline in EBITDA margin was partially offset by cost transfer price increases and favourable exchange rate impacts during F2022.

Q1 F2023 revenue increased 2.4%, reaching $707 million compared to $691 million in Q1 F2022, resulting primarily from exchange rate tailwinds and YOY revenue growth related to recent acquisitions, partially offset by organic decline in the Printing segment. DBRS Morningstar-calculated EBITDA for Transcontinental declined modestly YOY to $84 million in Q1 F2023, compared to $89 million in Q1 F2022, primarily driven by the decline in printing volume, partially offset by growth in the Packaging sector and positive exchange rate impact.

In terms of Transcontinental’s financial profile, F2022 FCF after dividends and before changes in working capital declined to $92 million from $139 million in F2021 (-33.9% YOY), primarily driven by higher income taxes paid during the period. Transcontinental increased its acquisition activity for the second straight year with the acquisitions of H.S. Crocker Co. Inc. ($52.7 million), Éditions du Renouveau Pédagogique Inc. ($57.2 million), Banaplast S.A.S. (18.4 million), and Scolab Inc. ($12.5 million). The modest decline in earnings coupled with a modest increase in lease- adjusted debt, resulted in weaker credit metrics as gross debt-to-adjusted EBITDA increased to 2.58 times (x) in F2022 compared with 2.42x in F2021. Furthermore, softness in Q1 F2023 operating results, and an increase in gross debt during the quarter resulted in gross debt-to-EBITDA weakening to 2.69x for the last 12 months ended Q1 F2023.

Looking ahead, DBRS Morningstar believes that Transcontinental’s earnings will be subdued in F2023 due to a challenging macroeconomic environment. Revenue is expected to grow modestly, increasing to over $3 billion in F2023, before increasing toward $3.1 billion through F2025. DBRS Morningstar believes Packaging segment revenue will grow as a result of organic growth due to new contracts and the passing on of inflationary cost increases, as well as the full- year impact of acquisitions made in F2022. DBRS Morningstar believes that revenue in the Print segment will decline modestly, reflecting inflationary pressures and the subsequent impact on volumes will more than offset the transfer of cost increases, and increased printing and in-store marketing volume. In terms of EBITDA margins, DBRS Morningstar expects margins will remain pressured in F2023, declining marginally due to persistent inflationary pressure and lower print volumes, despite cost-savings initiatives and improving packaging profitability as the Company looks to continue to catch up on input cost increases. Consequently, DBRS Morningstar forecasts the Company’s EBITDA will decline into the $430 million to $440 million range in F2023, before increasing to over $450 million by through F2025.

The assumption of the allocation of FCF toward debt reduction is expected to drive key credit metric improvement in F2023 and, consequently, strengthen the Company’s credit profile. DBRS Morningstar forecasts FCF after dividends and before changes in working capital will be approximately $90 million in F2023, as a normalization in income taxes paid is offset by lower net income and higher capital expenditures, while dividend payments remain flat YOY. The Company is expected to prioritize using internally generated cash flow toward debt reduction for the foreseeable future, although Transcontinental has a history of using its balance sheet to fund accretive acquisitions that are followed by periods of concentrated deleveraging. As such, DBRS Morningstar expects F2023 DBRS-Morningstar calculated gross leverage to be approximately 2.25x in F2023 and improve toward 2.0x over the medium term.

Should gross leverage move in a sustainable manner to below 2.0x and the Company continues to grow the Packaging segment such that consolidated operating income grows on a consistent basis, a positive rating action may occur. Conversely, if deterioration in operating performance leads to a sustained erosion of market share and/or more aggressive financial management, the rating may be pressured.

ENVIRONMENTAL, SOCIAL, GOVERNANCE 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 (May 17, 2022).

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

DBRS Morningstar applied the following principal methodologies:
-- Global Methodology for Rating Companies in the Services Industry (February 14, 2023) https://www.dbrsmorningstar.com/research/409773
-- Global Methodology for Rating Companies in the Industrial Products Industry (February 14, 2023) https://www.dbrsmorningstar.com/research/409775

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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 rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is a solicited credit rating.

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.

Information regarding DBRS Morningstar ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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