DBRS Limited (Morningstar DBRS) confirmed Transcontinental Inc.'s (Transcontinental or the Company) Issuer Rating and Senior Unsecured Debt Rating at BBB (low).

All trends are Stable.

KEY CREDIT RATING CONSIDERATIONS

The confirmation reflects the Company's resilient operating results in F2023 and Q1 F2024, in the midst of a challenging operating environment. While Transcontinental's sales declined to the low single digits for the last 12 months ended January 31, 2024 (LTM), primarily driven by lower volumes in the print segment, this negative impact has been offset by margin improvement as a result of driving operating efficiencies and cost cutting initiatives mainly in the packaging segment. As a result, adjusted EBITDA remained flat in F2023 and increased modestly in Q1 F2024. The Stable trends reflect Morningstar DBRS' expectation that the continued effect of the implementation of operating efficiency improvement initiatives and near term deleveraging will strengthen the Company's credit risk profile within the current rating category, despite Morningstar DBRS' expectation of modest revenue moderation for the full year F2024. The credit ratings continue to reflect the significant benefits of diversification that the Company has experienced with the Packaging segment, which now represents 57% of consolidated F2023 revenue (up from approximately 11% in F2016).

CREDIT RATING DRIVERS

A positive credit rating action could occur should the Company continue to grow the Packaging segment, such that consolidated operating income grows on a consistent basis, coupled with gross leverage moving below 2.0 times (x) in a sustainable manner. Conversely, a deterioration in operating performance, for example, one that contributes to a sustained erosion of market share and/or more aggressive financial management than anticipated, such that Morningstar DBRS-adjusted leverage increases above 3.0x for an extended period, could result in a negative credit rating action. Morningstar DBRS also notes that Transcontinental has a history of using its balance sheet to fund accretive acquisitions that are followed by periods of concentrated deleveraging.

EARNINGS OUTLOOK

Morningstar DBRS anticipates Transcontinental's earnings will be relatively stable year-over-year in F2024, as a decline in top-line is expected to be offset by improving profitability. Revenue is expected to decline in the low single digits in F2024 toward $2.90 billion and then increase moderately in F2025. Morningstar DBRS expect revenue in the Packaging segment will remain relatively flat in F2024, as the full-year impact of price increases from F2023 offset the impact of lower volumes, at least in the first half of the year, while in the context of a weaker macroeconomic environment. Print segment revenue is expected to decline in the mid-single digits in F2024, as lower volumes in the legacy print operations more than offset higher in-store marketing (ISM) volumes and inflationary price increases. In terms of EBITDA margins, we forecast Transcontinental to benefit from efficiency improvement initiatives, which include improving efficiency related to assets acquired over the last four to five years; however, cost-cutting initiatives are expected to be offset by weaker operating leverage, particularly in the print segment. As such, we believe EBITDA margins will remain stable at just over 15% but increase toward 15.5% in F2025. As a result, adjusted EBITDA is expected to remain flat at approximately $450 million in F2024 before experiencing modest growth in F2025.

FINANCIAL OUTLOOK

In terms of Transcontinental's financial profile, Morningstar DBRS expects key credit metrics to strengthen to a level considered strong for the current BBB (low) rating category in the near term, as the Company continues to prioritize deleveraging in F2024. Free cash flow (FCF) after dividends and before changes in working capital is forecast to improve into the $110 million-$120 million range in F2024, reflecting lower capital expenditures of approximately $135 million, coupled with stable year-over-year earnings and dividend payments. Furthermore, Transcontinental is expected to generate up to $100 million in real estate asset sales through F2025, with the majority occurring in F2025. As such, Morningstar DBRS expects the Company to allocate the majority of FCF toward debt reduction in the near term, such that gross leverage improves to approximately 2.0x in F2024.

CREDIT RATING RATIONALE

Transcontinental's credit ratings remain supported by the Company's strong market position in the print industry, attractive long-term outlook in the Packaging segment, diversified customer base and product offerings, and strong FCF-generating capacity. The credit ratings also continue to consider the structural shift to digital media from print, as well as the risks associated with growth through acquisition.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Environmental (E) Factors

There were no Environmental factor(s) that had a relevant or significant effect on the credit analysis.

Social (S) Factors

There were no Social factor(s) that had a relevant or significant effect on the credit analysis.

Governance (G) Factors

There were no Governance factor(s) that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)

A)	Weighting of BRA Factors

In the analysis of Transcontinental, Inc., the BRA factors were considered in the order of importance contemplated in the methodology.

B)	Weighting of FRA Factors

In the analysis of Transcontinental, Inc, the FRA factors were considered in the order of importance contemplated in the methodology.

C)	Weighting of the BRA and the FRA

In the analysis of Transcontinental, Inc, the BRA carries greater weight than the FRA.

Notes:

All figures are in Canadian Dollars unless otherwise noted.

Morningstar DBRS applied the following principal methodologies:

Global Methodology for Rating Companies in the Services Industry (15 April 2024)

https://dbrs.morningstar.com/research/431185/global-methodology-for-rating-companies-in-the-services-industry

Global Methodology for Rating Companies in the Industrial Products Industry (15 April 2024)

https://dbrs.morningstar.com/research/431173/global-methodology-for-rating-companies-in-the-industrial-products-industry

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024) - https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings, which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodology has also been applied:

Morningstar DBRS Global Corporate Criteria (15 April 2024)

https://dbrs.morningstar.com/research/431186/morningstar-dbrs-global-corporate-criteria

Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

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 info-DBRS@morningstar.com.

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

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

Morningstar DBRS 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. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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