Fitch Ratings has downgraded the Long-Term Issuer Default Ratings (IDRs) for
Fitch has also downgraded the senior secured term loan facility to 'B-/RR1' from 'B'/'RR1'.
The downgrade reflects Fitch's view that the strategic linkage between
Fitch could take further negative rating actions if Canopy pursues a repayment/refinancing of the remaining 2023 notes that Fitch considers a distressed debt exchange (DDE) per our criteria, if liquidity appears constrained such that a default is probable, or if the company does not successfully execute their premiumization cultivation strategy.
Key Rating Drivers
Debt Repayment Expected: Canopy entered into agreements with certain lenders under its term loan credit agreement to amend terms and tender for
Canopy also intends, if shareholders approve the creation of the exchangeable shares, to negotiate an exchange agreement with
Reduced Liquidity: If the two capital structure transactions are completed, this would reduce the overall debt in Canopy's capital structure by approximately 27% and reduce annualized interest expense by around
Parent-Subsidiary Linkage: Fitch believes the strategic linkage between Constellation and Canopy has materially diminished. As such, Canopy's ratings no longer benefit from a one-notch uplift from its standalone credit profile. In connection with the proposed transactions recently announced by Canopy, assuming approval and adoption of certain amendment proposals including the special resolution authorizing an amendment to create a new class of non-voting Canopy exchangeable shares, Constellation has expressed its current intention to convert all of its common Canopy shares into exchangeable shares.
As part of this conversion, all commercial agreements between Canopy and Constellation will be terminated, Constellation will no longer have board rights or approval rights over certain transactions, and any restrictive covenants previously agreed between the parties will terminate. Across Canopy's corporate structure, Fitch's equalizes the IDRs.
If Canopy receives approval from all parties, it expects to close all the transactions by the second half of fiscal 2024. As contemplated, Canopy would not directly own any of the
Execution Risk with Cultivation Strategy: Canopy has lost significant market share in the Canadian market due to its transition from low-margin value flower, execution missteps and challenges with pivoting its cultivation strategy. This has delayed production of a consistent, higher-quality supply at commercial scale and generated weak operating results with an uncertain path to profitability. Canopy hopes to counter these issues with a change in its genetics and cultivation strategy to higher quality cannabis with the right attributes (i.e. higher THC, single-strain, good terpenes) for the premium and mainstream flower, pre-rolls, edible and vape markets, while using the value segment as an outlet strategy.
Fitch views Canopy's premiumization strategy and increased distribution plans for BioSteel as reasonable, but there are still significant execution risks. The company believes it made material progress with its strategy given growth and positive mix shift during 4Q22 and expects to have 100% of internally sourced cannabis available for 2H23, supplemented by partnerships with craft growers of selective strains. However, Canopy will also need to drive retail velocities focused on budtender education and point-of-sale merchandising. BioSteel plans to materially increase distribution to more than 50,000 points by FYE 2023 as the company invests in the brand.
Derivation Summary
Canopy is rated lower than
Legends' rating reflects the ongoing recovery of the company's financial metrics following pandemic-related disruptions to its business model, which drove Fitch-calculated EBITDA negative in 2020, with Fitch expecting leverage to return to the low-7x in 2022 and FCF approaching neutral in 2023.
KDC's 'B-' IDR reflects KDC's status as a global leader in custom formulation, packaging and manufacturing solutions for beauty, personal care and home care brands, supported by a diverse product portfolio and customer base, ranging from blue-chip names to 'indie' brands, which the company typically maintains long-term relationships.
Fitch expects KDC's broadening platform, including the recent
Key Assumptions
Fitch's Key Assumptions Within the Rating Case for the Issuer:
Revenue increase of approximately 8% in fiscal 2023 to mid-CAD500 million range supported by successful execution on the genetics cultivation strategy reflecting increased premium and mainstream market shares, increased distribution of BioSteel and volume growth in Storz and Bickel products. Growth in fiscal 2024 to around
EBITDA deficit in the mid
Capital spending of around
FCF deficit of close to
Successful repayment/refinancing of convertible notes maturity;
The forecast does not assume any changes contemplated resulting from Canopy's recent announcement.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Good execution with ongoing strategic initiatives that results in greater clarity around a pathway to profitability that generates positive EBITDA, significant reduction in operating deficits and improved liquidity to fund ongoing operations and necessary investments over the next 24 to 36 months;
Positive changes in the regulatory environment.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Canopy enters into a debt restructuring that could be classified as a DDE per Fitch's criteria including an equity-like exchange with convertible bondholders;
If liquidity appears constrained such that a default appears probable;
Lack of execution on premiumization strategy and profitability improvement that is materially lower than expectations of Canopy reaching EBITDA positive in fiscal 2024 that raises concerns about the sustainability of its capital structure.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
Liquidity and Debt Structure
High Cash Burn, Weakening Liquidity: The ongoing cash burn and M&A strategy, combined with market conditions, have eroded Canopy's liquidity position and could hamper its ability to access additional capital. Cash, cash equivalents and short-term investments totaled
The
This repayment, while reducing debt and annual interest payments, will further weaken Canopy's liquidity position. Additionally, as part of the credit agreement amendment, the
The previous exchange of the senior convertible notes in
Recovery Considerations
For issuers with IDRs at 'B+' and below, Fitch performs a recovery analysis for each class of obligations. Issue ratings are derived from the IDR and the relevant Recovery Rating (RR) and notching based on expected recoveries in a distressed scenario. Fitch takes the higher of liquidation value or enterprise value (EV, based multiple applied to the stressed EBITDA) to determine the waterfall recoveries.
The 5.5x for Canopy considers historical bankruptcy exit multiples for CPG companies ranging from 4.0x to 10.0x, with a median reorganization multiple of 6.3x. The multiple for Canopy also considers Canopy's brands. Fitch considers the value accorded to the agreements to purchase interests for Wana, Jetty Extracts,
For Canopy, the recovery of the
In deriving a liquidation value of the assets for around
Following a 10% reduction for administrative claims, the recovery analysis for the term loan results in a recovery corresponding to 'B-'/'RR1'.
Issuer Profile
Canopy is a leading global diversified cannabis and hemp company based in
Summary of Financial Adjustments
Fitch adjusted the fair value of debt to reflect debt amount payable on maturity, stock-based compensation, transactions expenses, impairments and restructuring costs.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
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