DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Senior Debentures rating of SNC-Lavalin Group Inc. (SNC or the Company) at BBB (low) and maintained the Negative trend. On July 24, 2019, DBRS Morningstar downgraded the ratings to BBB (low) from BBB and changed the trend to Negative from Stable, noting the substantially weaker-than-anticipated Q2 2019 results and slower-than-expected recovery in the Company's financial metrics during 2019. This rating confirmation is supported by a relatively better performance during H2 2019, comfortable liquidity position with cash balances of $1.2 billion as at December 31, 2019, and the Company's ongoing efforts to execute the new strategy focusing on engineering service offerings and exiting lump-sum turnkey contracting. Although SNC's operating performance and financial metrics were weaker in F2019 compared with F2018, DBRS Morningstar factored this weakening of metrics into the rationale for the downgrade in 2019. The Negative trend has been maintained because SNC needs to demonstrate recovery in earnings and improvement in credit metrics amid the challenges of delivering the legacy lump-sum turnkey contract backlog and strategic overhaul as well as prudently managing its financial position. However, DBRS Morningstar notes that the Company forecasts do not factor in the impact of the Coronavirus Disease (COVID-19) pandemic on the Company's operating performance, due to the highly uncertain and rapidly evolving nature of the scenario. While SNC's construction operations will be temporarily disturbed due to COVID-19 during H1 2020, DBRS Morningstar expects that SNC should be able to bounce back quickly once the situation normalizes, given the essential nature of several of its construction projects. DBRS Morningstar will continue to closely monitor the situation and opine or take necessary action in case of material developments, including those related to the COVID-19 pandemic.
After recurrent execution challenges in the engineering, procurement, and construction sector and a challenging H1 2019, SNC announced a reorganization of its business model and new strategic plan on July 22, 2019, to de-risk its business profile. As part of the strategic plan, the Company decided to discontinue bidding on lump-sum turnkey construction contracts and focus primarily on its design and engineering service offerings. During the year, the Company appointed Ian Edwards as the chief executive officer and formed a project oversight function to ensure centralized monitoring and timely completion of the lump-sum contract backlog. Revenues and adjusted EBITDA declined by 6% and 48% respectively, year-over-year during 2019 as SNC encountered challenges on several turnkey construction projects in the Infrastructure and Resources segment. While operating performance during H2 2019 was relatively better than in H1 2019, the full year performance for F2019 was marked by a significant amount of restructuring and impairment costs as SNC tried to revamp its business strategy and exit non-profitable divisions.
In August 2019, SNC completed the $3.0 billion sale of 60% of its 16.77% ownership interest in 407 International Inc. (rated "A" with a Stable trend by DBRS Morningstar), the company responsible for the Highway 407 electronic toll route (ETR) project. The sale proceeds enhanced SNC's financial flexibility in a challenging operating year and were largely utilized for debt reduction with the balance being held as cash. Debt reduction helped prevent further deterioration in its credit metrics during H2 2019, as the Company's adjusted debt to EBITDA ratio and the EBITDA interest coverage ratio stood at 3.8 times (x) and 4.3x respectively—in line with expectations at the time of downgrade.
Further, on December 18, 2019, SNC settled legal proceedings related to fraud and corruption charges by agreeing to pay a $280 million penalty over five years. DBRS Morningstar views this as positive because it helps to deal with a key overhang that could have resulted in materially negative event risk.
Going forward, DBRS Morningstar expects SNC to demonstrate prudent financial management and improve adjusted debt-to-EBITDA ratio to 3.0x or below in the near to medium term through recovery of earnings and/or debt reduction. DBRS Morningstar notes that progress made towards completion of the legacy lump-sum contract backlog without material project losses and improvement in credit metrics would be the key drivers for reinstating the Stable trend. However, additional project and operational challenges that prevent earnings recovery and lead to further deterioration in credit metrics (including those related to the COVID-19 pandemic) could trigger negative rating action.
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.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Rating Companies in the Construction and Property Development Industry (November 2019), DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2019), DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 2020), 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.
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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.
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