DBRS Limited (DBRS Morningstar) downgraded CanWel Building Materials Group Ltd.'s (CanWel or the Company) Issuer Rating and Senior Unsecured Notes (the Notes) rating to B from B (high) and changed the trend to Negative.
DBRS Morningstar also confirmed the Recovery Rating for the Notes at RR4. The ratings have been removed from Under Review with Negative Implications, where they were placed on April 13, 2020. The rating actions reflect DBRS Morningstar's view that the Coronavirus Disease (COVID-19) pandemic and the macroeconomic aftereffects will have a material negative impact on CanWel's earnings profile and will likely cause key credit metrics to deteriorate beyond a level that is considered acceptable for the current rating for an extended period.
On April 13, 2020, DBRS Morningstar placed CanWel's ratings Under Review with Negative Implications, reflecting DBRS Morningstar's view that CanWel's revenues and operating income would experience lower volumes as a result of curtailed construction spending and government-mandated business closures for at least the near term. DBRS Morningstar also noted that a larger concern for the rating is the potentially longer-lasting effects that the coronavirus outbreak will have on the economy, as CanWel's products are used primarily in home construction, renovation, and remodelling.
Since then, CanWel reported its results for the first quarter ended March 31, 2020 (Q1 F2020). Net sales increased 7.9% to $1.38 billion in the last 12 months ended Q1 2020 (LTM ended Q1 2020) versus $1.28 billion in the LTM ended Q1 2019, primarily because of the contribution from Lignum Forest Products LLP (Lignum), which was acquired in April 2019. EBITDA margins increased to 6.4% for the LTM ended Q1 2020 versus 5.1% for the LTM ended Q1 2019, primarily because the adoption of IFRS 16 standards partially offset a decrease in pricing levels and contribution from lower-margin Lignum business. The Company used cash flow from operations of $61.0 million during the LTM ended Q1 2020 primarily for dividend payments of $44 million and capital expenditures (capex) of $6 million. The Lignum acquisition and other investment activities resulted in additional cash outflow of $16 million during the LTM ended Q1 2020. Total balance sheet debt at the end of Q1 F2020 increased to $534 million from $511 million in Q1 F2019, and as such, the key credit metric of lease-adjusted debt-to-EBITDAR increased to 6.09 times (x) at the end of the LTM ended Q1 2020 versus 5.75x for the LTM ended Q1 2019. DBRS Morningstar notes that CanWel has initiated certain liquidity-based measures, including reduction in working capital levels that would help in lowering revolving credit utilization, cost optimization initiatives, deferring or reducing debt/lease payments, and reducing capex. Additionally, the Company is evaluating government financial support programs in order to offset some of the potential impact of the pandemic on the Company's operations.
Looking ahead, DBRS Morningstar believes that the coronavirus pandemic and the related macroeconomic aftereffects will result in meaningful headwinds for the remainder of F2020 and well into 2021. A number of factors, including gross domestic product and unemployment, affect CanWel's sales because customers use CanWel's products primarily for home construction, renovation, and remodelling. DBRS Morningstar expects Canada's and the U.S.' GDP to contract at least by 6% and 5% in 2020, respectively, and predicts unemployment to be approximately 11% and 10%, respectively. As such, DBRS Morningstar expects CanWel's revenues to decline by around 10% for the full-year F2020 and EBITDA to decline by around 20% to approximately $70 million. DBRS Morningstar expects this earnings pressure will persist well into F2021, considering a recessionary backdrop.
The decline in earnings will in turn weaken CanWel's financial profile based on a corresponding contraction in cash flows, causing key credit metrics to deteriorate to a level beyond what is considered acceptable for the current rating (i.e., lease-adjusted debt-to-EBITDAR of around 6.0x) for the remainder of 2020 and through 2021. DBRS Morningstar believes cash flow from operations should track the operating income and fall in the $45 million to $50 million range in 2020 and 2021. Capex is expected to decrease in 2020 to approximately $2 million and increase only modestly in 2021. Should the Company maintain dividend outflows at existing levels of around $44 million, the Company's free cash flow (after dividends and capex but before changes in working capital) will remain in a deficit position and materially weaken CanWel's overall financial risk profile.
The Negative trend reflects DBRS Morningstar's concern that the Company may not take appropriate capital conserving measures with respect to the Company's dividend policy and to a lesser degree the risk of the Company's earnings profile further weakening in F2021. Should EBITDA remain at levels above $70 million, DBRS Morningstar believes that the Company will have the ability to defend the B rating category when combined with an appropriate reduction in dividend outlay such that key credit metrics do not deteriorate beyond a range acceptable for the new rating (i.e., lease-adjusted debt-to-EBITDAR of not above 7.0x for a sustained period), adjusted for seasonal debt balance fluctuations. Conversely, should CanWel's credit profile weaken further as a result of weaker-than-expected operating performance and/or aggressive financial management, a further negative rating action could result.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
Notes:
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Rating Companies in the Merchandising Industry (August 15, 2019), Rating Companies in the Forest Products Industry including Appendix I - Timberland Operators (March 19, 2020), DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers (August 22, 2019), and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019), which can be found on dbrsmorningstar.com under Methodologies & Criteria.
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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Ratings
Date Issued Debt Rated Action Rating Trend Recovery Rating Issued
i
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01-Jun-20 Issuer Rating Downgraded B Neg CA
01-Jun-20 Senior Unsecured Notes Downgraded B Neg RR4 CA
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