DBRS Limited (DBRS Morningstar) downgraded the Issuer Rating and Senior Unsecured Notes rating of Saputo Inc. (Saputo or the Company) to BBB from BBB (high) and changed the trends on the ratings to Stable from Negative. The downgrade reflects the Company’s declining operating performance, which began in the fourth quarter of the fiscal year ended March 31, 2021 (Q4 F2021) and continued through F2022, resulting in a credit risk profile that is no longer commensurate with the previous BBB (high) ratings. The Stable trends reflect DBRS Morningstar’s expectation that credit metrics should improve to a level supportive of the BBB rating category by F2024 through earnings growth that is expected to benefit from ongoing pricing and operating efficiency initiatives.
On November 19, 2021, DBRS Morningstar confirmed Saputo’s Issuer Rating and Senior Unsecured Notes rating at BBB (high) and changed the trends to Negative, which reflected the Company’s deteriorating operating performance that began in Q4 F2021 and worsened over the first half of F2022 (six months ended September 30, 2021 (H1 F2022)). DBRS Morningstar also commented that a near-term recovery may be difficult to achieve amid challenging market conditions, including commodity price volatility, inflationary pressure on input costs, labour shortages, and supply chain disruptions. At that time, DBRS Morningstar stated that, should a meaningful recovery in EBITDA from a combination of margin and/or volume growth not occur in the next one to two quarters, the ratings could be downgraded regardless of capital-conserving measures undertaken by the Company to improve credit metrics through debt reduction.
Since DBRS Morningstar’s last rating action, Saputo reported results for the second half of F2022 (six months ended March 31, 2022 (H2 F2022)). In H2 F2022, revenue grew by over 9% year over year (YOY) and from H1 F2022 levels to approximately $7.9 billion. The topline continued to benefit from additional selling price increases and a modest contribution from new, small-scale acquisitions, while volumes remained relatively stable YOY. As such, revenue increased above $15 billion in F2022 from $14.3 billion in F2021. That said, EBITDA declined to $582 million in H2 F2022, down 21% YOY and relatively flat on H1 F2022 levels. EBITDA remained pressured by rapidly rising commodity prices and input costs that continued to outpace selling price increases, as well as operational inefficiencies resulting from sustained labour shortages in some geographies and ongoing supply chain disruptions. Consequently, F2022 EBITDA declined to approximately $1.2 billion, well below F2021 levels of around $1.5 billion. The material decline in EBITDA, coupled with a modest increase in debt to partially finance new acquisitions, resulted in debt-to-EBITDA deteriorating to 3.7 times (x) in F2022 compared with 2.8x in F2021, a level no longer commensurate with the BBB (high) rating category (i.e., debt-to-EBITDA of less than 2.75x).
In the near term, DBRS Morningstar expects commodity price volatility and inflationary cost pressures to persist, and acknowledges that the Company could respond with more aggressive and timely pricing actions, which should provide gradual EBITDA relief over the course of F2023. That said, DBRS Morningstar believes that Saputo could be challenged to continue to pass through these cost pressures without affecting volumes and mix. DBRS Morningstar also expects ongoing labour and supply chain constraints in some geographies to continue to pressure Saputo’s operating performance, and anticipates that the Company’s recruiting and retention initiatives, SKU rationalization, and investments in network consolidation and streamlining, as well as automation, may only partially mitigate the effect thereof in the back half of F2023. As such, DBRS Morningstar projects a modest increase in EBITDA to approximately $1.3 billion in F2023. DBRS Morningstar forecasts EBITDA to grow above $1.5 billion in F2024, largely benefitting from initiatives to streamline Saputo’s operations and improve operating efficiencies. Furthermore, operating performance should continue to benefit from further potential selling price increases and volume recovery.
DBRS Morningstar forecasts free cash flow (FCF) (after dividends and before changes in working capital) to be in a deficit position in F2023, and, as such, expects debt to increase in that fiscal year. This view is based on DBRS Morningstar’s projections that operating cash flow will continue to trend in line with earnings, the cash dividend outlay will be modestly larger, and capital expenditure will increase above $700 million in line with the Company’s strategy to invest $2.3 billion over four years (F2022 to F2025) to grow EBITDA. Conversely, in F2024, DBRS Morningstar forecasts FCF (after dividends and before changes in working capital) to grow above $100 million, primarily attributable to the anticipated growth in earnings. DBRS Morningstar believes that if Saputo continues to make small-scale acquisitions that support its growth strategy, these acquisitions could be funded by a reallocation of capital resources and/or available liquidity and FCF rather than through additional indebtedness. Consequently, DBRS Morningstar forecasts debt-to-EBITDA to improve to 3.5x in F2023, remaining above the 3.25x threshold considered appropriate for the BBB rating category, and improve below 3.25x in F2024.
That said, DBRS Morningstar acknowledges that the uncertainty surrounding the macroeconomic outlook presents a significant downside risk to DBRS Morningstar’s forecasts, and notes that a protracted economic downturn could pressure Saputo’s operating performance and cash flow generation. Furthermore, should the Company be challenged to continue to pass through inflationary pressure and improve operating efficiencies, this will further pressure Saputo’s operating performance and cash flow generation. These pressures could result in increased borrowing requirements to finance the Company’s ambitious capital investment plan and small-scale acquisitions. As such, should operating performance deteriorate significantly beyond DBRS Morningstar’s current expectations such that credit metrics persist at levels that are high for the current rating category (i.e., debt-to-EBITDA above 3.25x) beyond F2023, a further negative rating action could result.
Saputo’s ratings continue to be supported by its leading market position, diversification of operations by distribution channel and geography, and strong FCF generation. The ratings also continue to reflect the Company’s exposure to volatile commodity prices, the highly competitive industry, and the risks associated with the mature geographies in which Saputo operates.
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/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Rating Companies in the Consumer Products Industry (July 26, 2021; https://www.dbrsmorningstar.com/research/382072) and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (April 4, 2022; https://www.dbrsmorningstar.com/research/394683), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022; https://www.dbrsmorningstar.com/research/396929).
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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.
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.
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