DBRS Limited (DBRS Morningstar) confirmed Corus Entertainment Inc.’s (Corus or the Company) Issuer Rating at BB and changed the trend to Negative from Stable. The trend change reflects DBRS Morningstar’s concerns that Corus’s near-term earnings will remain under pressure as a result of a contraction in advertising revenue as the industry grapples with signs of slowing economic activity. As such, DBRS Morningstar is concerned that the business risk profile and corresponding key credit metrics could deteriorate beyond the level considered appropriate for the current rating category.
On April 13, 2022, DBRS Morningstar confirmed Corus’s Issuer Rating at BB with a Stable trend. The rating confirmation reflected a continued measured recovery in F2021 financial performance, which had continued into the first half of F2022, and the expectation that the advertising recovery would continue, as would the Company’s commitment to debt reduction.
At that time, DBRS Morningstar forecast F2022 EBITDA to decline in the high-single digits largely as a result of wage and programming pressures and higher required spending on Canadian content. Leverage was expected to be roughly flat year over year (YOY) at 2.85 times (x) by the end of F2022, mainly benefitting from debt reduction, but ended higher than expected. Furthermore, DBRS Morningstar’s outlook on Corus’s earnings profile has since weakened.
After showing improvement in F2021, Corus’s earnings were challenged in F2022 as the macroeconomic environment became more uncertain and advertising demand softened. While F2022 consolidated revenue growth was positive for the year, EBITDA declined meaningfully YOY, primarily reflecting higher programming costs, inflationary pressure on compensation, a catch-up obligation for Canadian content spending, and the absence of wage subsidies and regulatory fee relief. Softness in the advertising market combined with continued meaningful increases in direct costs; employee compensation; and higher sales, general, and administrative (SG&A) costs flowed into Q1 F2023 and the overall economic environment remains unstable.
In F2022, consolidated revenue increased 4% YOY to $1,599 million, although revenue performance was somewhat varied through the year, but softened noticeably in Q4 F2022. Growth in F2022 reflected an improvement in radio from a fairly depressed base in F2021 was up 9% YOY, whereas Television posted a 3% YOY growth rate and continued to struggle with some traditionally strong sectors still not near prepandemic advertising spending such as autos, groceries, and entertainment. While revenue was up modestly, F2022 EBITDA declined 15% YOY to $444 million, which was below DBRS Morningstar’s expectations, driven by a 16% YOY increase in direct costs of sales, 6% YOY growth in compensation costs, and a 20% increase in SG&A.
Operating results continued to be challenged in Q1 F2023 with revenue of $431 million, down 7% YOY, as TV advertising revenue remained under pressure, declining 11% YOY, and subscriber revenue was flat. Q1 F2023 EBITDA of $132 million was down 26% YOY, primarily reflecting higher program rights costs that were driven by an increase in original programming compared with the prior year, a modest increase in employee costs, and an increase in marketing costs, which DBRS Morningstar expects to remain a headwind throughout the year. Overall, Q1 F2023 EBITDA margin was 31% compared with 38% in Q1 F2022.
The soft earnings results were also reflected in the Company’s financial profile. In F2022, free cash flow (FCF) after dividends and before changes in working capital declined 12.8% YOY to $207 million from $238 million, primarily reflecting lower net income, as capital expenditures (capex) of $18 million and $69 million in dividend payments were roughly flat YOY. Importantly, despite the challenging advertising market and softer-than-expected earnings, the Company continued to prioritize debt reduction, paying down $122 million of debt and thus ending the year with $1.3 billion of debt. However, as a result of the decline in EBITDA and despite a lower debt balance, gross debt-to-EBITDA increased to 3.15x, compared with 2.85x in F2021. In Q1 F2023, the debt balance remained virtually unchanged; however, given the weakness in quarterly EBITDA, last-12-month gross debt-to-EBITDA was 3.58x compared with 3.15x at year-end (YE) F2022.
DBRS Morningstar believes that the challenging advertising environment will likely persist through F2023. However, while advertising spending cuts are typically on the vanguard of economic softness, it can also recover quickly. A strong slate of programs, access to specialty channels, a robust production slate of Canadian content that has international appeal, the ability to deliver premium content across a wide array of channels, the continued development of digital advertising solutions, and a resilient subscriber base position Corus well to benefit when advertising recovers. As a result, DBRS Morningstar expects F2023 revenue to decrease in the low-to-mid single digits and then increase in the mid-single digits in F2024. DBRS Morningstar expects the EBITDA pressure witnessed in Q1 F2023 to persist through the year, but moderate as the year progresses as the Company takes measures to curb costs and anniversaries easier annual comparables than in the first quarter. As a result, DBRS Morningstar expects EBITDA to decline in the mid-to-high single digits in F2023, before stepping up in F2024, in part related to catch-up Canadian content costs rolling off.
DBRS Morningstar forecasts F2023 FCF after dividends and before changes in working capital to be $110 million to $120 million, down from $207 million in F2022, largely reflecting a decline in net income, partially offset by a lower level of dividend payments related to the Company’s announcement on March 6, 2023, to halve the dividend. DBRS Morningstar expects the Company to continue to prioritize using internally generated cash flow toward reducing the balance of its term facility for the foreseeable future. While debt is expected to continue to decline in F2023, owing to the softness in EBITDA, YE F2023 gross leverage is expected to weaken to approximately 3.25x, before improving to well below 3.0x at YE F2024.
Looking ahead to F2024 and into F2025, if key credit metrics remain under pressure and/or leverage is maintained at a structurally higher level as a result of weaker-than-expected operating performance and/or more aggressive financial management, a negative rating action may occur. Conversely, should operating performance strengthen, combined with the continued allocation of FCF towards debt reduction such that gross leverage stabilizes near or below 3.0x, DBRS Morningstar may change the trend to Stable from Negative.
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 (May 17, 2022).
All figures are in Canadian dollars unless otherwise noted.
DBRS Morningstar applied the following principal methodologies:
-- Rating Companies in the Broadcasting Industry (March 14, 2023; https://www.dbrsmorningstar.com/research/410794).
-- DBRS Morningstar Global Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (September 1, 2022; https://www.dbrsmorningstar.com/research/404248).
-- DBRS Morningstar Global Criteria: Guarantees and Other Forms of Support (March 28, 2023; https://www.dbrsmorningstar.com/research/411694).
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.
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