DBRS Morningstar Downgrades Issuer Rating on Corus Entertainment Inc. to BB (low) from BB, Changes Trend to Stable from Negative

DBRS Limited (DBRS Morningstar) downgraded Corus Entertainment Inc.’s (Corus or the Company) Issuer Rating to BB (low) from BB and downgraded the Senior Unsecured Notes to BB (low) from BB; however, there is no change to the recovery rating of RR4. DBRS Morningstar also changed all trends to Stable from Negative. The credit rating downgrades reflect DBRS Morningstar’s concerns that Corus’ near- to medium-term earnings will remain under pressure as a result of a contraction in advertising revenue affected by the confluence of several factors, including a softening economic outlook, strike activity (now resolved) affecting content creation, and an increasingly competitive entertainment landscape.

On April 12, 2023, DBRS Morningstar confirmed Corus’ Issuer Rating at BB, but changed the trend to Negative from Stable. The trend change reflected the concern that near-term earnings would be pressured by slowing economic activity.

At that time, DBRS Morningstar forecast F2023 EBITDA to decline in the high single digits largely as a result of a softening economic environment and programming pressures that would require higher spending on Canadian content. However, EBITDA was expected to trough in F2023 and increase year over year (YOY) in F2024. Further, leverage at YE F2023 was expected to be roughly 3.25 times (x) and trend down in subsequent years.

F2023 operating results were softer than anticipated with revenue of $1,511 million, down 5% YOY, as TV advertising revenue remained under pressure, declining 11% YOY, and subscriber revenue declined 3% YOY. F2023 EBITDA of $334 million was down 25% YOY, primarily reflecting higher program rights costs that were driven by an increase in original Canadian content production as well as investment in U.S. studio programming. The EBITDA decline was despite a mid-single-digit decline in general and administrative and compensation costs. As a result, the F2023 EBITDA margin was 22.1% compared with 27.8% in F2022.

The soft earnings results were also reflected in the Company’s financial profile. In F2023, free cash flow (FCF) after dividends and before changes in working capital declined 76% YOY to $48 million from $207 million, primarily reflecting lower net income before one-time items, as capital expenditures (capex) of $13 million and $53 million in dividend payments were both lower YOY. DBRS Morningstar note that $141 million in net proceeds from the sale of Toon Boom were directed toward debt repayment. As a result, debt declined to $1.22 billion at YE F2023 compared with $1.3 billion in the prior year. However, as a result of the decline in EBITDA and despite a lower debt balance, gross debt-to-EBITDA increased to 3.65x, compared with 3.15x in F2022.

DBRS Morningstar expects the challenging television advertising environment will likely persist through F2024 as advertisers moderate their ad-spend and consumers contend with the rising cost of living and higher interest rates. In addition, the Writers Guild of America and Screen Actors Guild-American Federation of Television and Radio Artists strikes have severely affected the production of U.S. content, which will negatively affect operating results in the company’s seasonally strong first quarter. However, with the resolution of both strikes as of early November, DBRS Morningstar anticipates a full program schedule to return in H2 F2024.

While the prospect of new content and the return of a full program schedule in the latter half of F2024 is encouraging, the proliferation of digital entertainment options (including subscription video on demand, free advertising supported TV, and advertising video on demand, all platforms on which Corus also has offerings), has intensified the competitive landscape and provides consumers with an ever-expanding range of entertainment options. While Corus’ video-first strategy offers a strong slate of popular programs, access to specialty channels and a robust production slate of Canadian content that has international appeal, the rising cost of living, and an uncertain economic climate are causing consumers to be pickier with regard to their entertainment spend. Therefore, in order to reduce ad-spend friction, the Company must be able to provide advertisers with a seamless buying experience that is both effective and efficient across all linear and digital distribution channels. Of note is that revenue from Corus’ streaming distribution platforms and digital video advertising offerings continue to grow, and now represent approximately 11% of TV advertising and subscription revenue, although the pace of growth slowed to 2% YOY in F2023. In order to leverage its premium content and remain relevant in the changing entertainment landscape, Corus will have to deepen its expertise in cross-platform selling, which is expected to take some time. As a result, DBRS Morningstar expects F2024 revenue to decrease in the high single-digit to low double-digit range and then increase in the low single-digits in F2025. DBRS Morningstar expects the EBITDA pressure witnessed in Q4 F2023 to persist through H1 F2024 but moderate as the year progresses as the Company takes measures to curb costs and faces easier YOY comparisons. As a result, DBRS Morningstar expects EBITDA to decline in the mid-to-high single digits in F2024, before returning to positive growth in F2025.

In terms of the financial outlook, Corus announced the suspension of its quarterly dividend when it reported YE F2023 results in order to prioritize continued debt reduction. DBRS Morningstar estimates F2024 FCF after dividends and before changes in working capital to be $110 million to $120 million, compared with $48 million in F2023, in part reflecting the absence of $36 million in dividend payments in F2023. DBRS Morningstar expects the Company to continue to prioritize using internally generated cash flow and/or proceeds from asset divestitures toward reducing the balance of its term facility for the foreseeable future. While debt is expected to continue to decline in F2024, owing to the softness in EBITDA, YE F2024 gross leverage is expected to remain roughly flat YOY at ~3.65x, before declining in F2025.

If key operating activity continues to deteriorate, particularly if Corus has a full program schedule, and/or credit metrics remain under pressure and/or leverage is maintained at a structurally higher level and/or the Company pursues a more aggressive financial management strategy (such as the reinstatement of a dividend while operating performance is under pressure), a negative rating action may occur. Conversely, should operating performance strengthen in a sustainable manner, combined with the continued allocation of FCF toward debt reduction such that gross leverage moves sustainably below 3.0x, DBRS Morningstar may consider a positive rating action.

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/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (July 4, 2023).

Notes:
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 (August 30, 2023; https://www.dbrsmorningstar.com/research/420063/dbrs-morningstar-global-criteria-recovery-ratings-for-non-investment-grade-corporate-issuers).

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.

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 [email protected].

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

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 credit ratings are under regular surveillance.

Information regarding DBRS Morningstar credit ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at [email protected].

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