DBRS Limited (DBRS Morningstar) downgraded the Issuer Rating and Senior Debentures rating of SNC-Lavalin Group Inc. (SNC or the Company) to BB (high) from BBB (low) and maintained the Negative trend. DBRS Morningstar also assigned a recovery rating of RR4 to the Senior Debentures. The downgrade is driven by recurrent losses in the Projects business and continued underperformance in SNC’s earnings and credit metrics during year-to-date (YTD) Q3 2020—when compared with other investment-grade peers. DBRS Morningstar notes that the recurrence of project losses (despite their arising from distinct projects and being one-off in nature) continues to surprise on the negative side and demonstrates a relative weakening of project control. The Negative trend is maintained as DBRS Morningstar remains concerned about earnings recovery and the potential for further challenges in the Projects business until the completion of the remaining lump-sum turnkey (LSTK) contract backlog.
At the time of the last downgrade in July 2019, DBRS Morningstar had factored in the weak Q2 2019 results and worsening of the adjusted debt-to-EBITDA ratio beyond 3.0 times (x) as of F2019, despite a profitable H2 2019. While DBRS Morningstar initially expected the earnings recovery to continue in 2020 after a strong H2 2019, the impact of the Coronavirus Disease (COVID-19) pandemic (despite the resilient nature of the construction sector) led us to revise our Base Case forecasts downward earlier this year, expecting credit metrics as of F2020 to be in line with last year. However, YTD Q3 2020 results and Q3 2020 results, in particular, indicate continued challenges in the Projects business (primarily due to a $58 million loss from an unfavourable arbitration ruling on a legacy LSTK project) and deterioration in credit metrics. This has led DBRS Morningstar to further adjust our forecasts downward with adjusted debt-to-EBITDA surpassing 4.2x as of F2020 (from 3.9x as of LTM September 30, 2020) and not improving to a level below 3.0x by the end of F2021, unless the Company repays a material portion of outstanding debt or demonstrates a strong earnings recovery in 2021 that exceeds our expectations.
DBRS Morningstar notes that SNC’s Engineering Services business has performed favourably during the pandemic and is expected to perform better going forward, compared to the Projects business. However, the outperformance of the Engineering Services business is insufficient to prevent a material earnings decline as of F2020 or drive strong earnings recovery for SNC during F2021.
DBRS Morningstar also notes that SNC is making positive strategic decisions: first with the announcement of exiting LSTK construction contracts in July 2019 and then with the proposed transformation of the Resources business in July 2020. On July 31, 2020, SNC announced its plans to scale down the Resources Services business to key regions (Americas and Middle East) and focus on completing the remaining LSTK Resources Projects backlog by Q1 2021. If SNC’s new strategy is executed as proposed with timely and on budget completion of the fixed-price project backlog, the Company’s business risk profile would be positively affected, notwithstanding the smaller scale of the remaining business. DBRS Morningstar notes that SNC could continue to face some losses in the Resources business at least until H1 2021 as the reduction in overheads for the Resources Services business (due to streamlining geographic presence) comes with a lag effect, and the likelihood of the Resources Projects business facing additional challenges remaining high. While the majority of the Resources Projects backlog might be completed by Q4 2020, DBRS Morningstar notes that the entire Resources Projects backlog will not be complete until H1 2021. Further, DBRS Morningstar notes that SNC’s Infrastructure Projects backlog includes some complex light-rail transit projects under fixed-price contracts that are expected to be completed by 2024.
Despite our expectations of gradual improvement in SNC’s business profile during the near to medium term, DBRS Morningstar maintains the Negative trend as earnings recovery remains a key issue. DBRS Morningstar would like SNC to demonstrate improvement in earnings and credit metrics, substantial progress towards completion of the Resources Projects backlog as well as stricter project control at least for two consecutive quarters before reinstating the Stable trend. However, if SNC’s credit metrics deteriorate further from our Base Case expectations through F2021 because of higher-than-anticipated losses (specifically, in the Projects business), incremental borrowings, or lower-than-expected EBITDA that keeps the adjusted debt-to-EBITDA ratio above 4.5x through 2021, this could cause further 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 28, 2019), DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019), DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 22, 2020) and DBRS Morningstar Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (August 24, 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.
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 firstname.lastname@example.org.
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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