DBRS Confirms 407 International Inc. at “A”

DBRS has today confirmed the ratings of 407 International Inc. (the Company or 407); all trends remain Stable. Despite its heavy debt burden, the Company continues to exhibit sound fundamentals, based on its high operational efficiency, solid cash flow generation, sizable reserves and healthy long-term traffic prospects. After years of steady growth, traffic volume on Highway 407 was flat in 2008 and displayed its first decline in 2009 (vehicle kilometres travelled (VKT) was down 1.68% year over year (yoy)), primarily due to the economic slowdown that persisted during that period. That said, the softness in traffic volume was less than DBRS had expected and 407 proved to be more resilient in an economic downturn than originally anticipated. The Company still recorded revenue growth of 2.5% in 2009 as rate increases more than offset lower VKTs. Normalized EBITDA grew by a higher rate than revenue (up 2.8%) as normalized operating expenses increased 1.1%. Lower cash flow, combined with significant increases in capex and dividends and the non-cash impact of higher inflation expectations on the Senior Bonds, Series 04-A2 (Series 04-A2), contributed to continued rise in debt balance.

DBRS expects VKT growth will return to positive territory (low to mid-single digits), driven by the economic recovery that began at the end of 2009. DBRS estimates that traffic growth, combined with a weighted-average toll increase of 7.7% and improved video tolling technology, will lead to revenue growth in the high single-digit range in 2010. Benefit from operating leverage and continued focus on efficiency improvement and cost containment should result in an even higher rate of growth for EBITDA in the year.

Healthy growth in operating cash flow will likely be the basis for further increases in dividends to shareholders as DBRS foresees 407 continuing with its general pattern of paying out the bulk of operating cash flow in dividends and using incremental debt to finance its capital expenditures. Notwithstanding our expectation for higher debt and interest expenses, we project leverage and coverage metrics to improve meaningfully, based on strong EBITDA growth in 2010.

Although 407’s operating performance has proven to be quite resilient and the practice of favouring equity distribution over balance sheet improvement is fairly common among public-private partnerships with a long concession term, the Company’s ability to absorb incremental debt within its current rating category is not limitless. DBRS expects the Company will continue to manage itself in a manner that would keep the financial profile and overall credit risk profile consistent with the current rating category; for example, by scaling back growth in debt in the event of sustained difficulty in the operating environment. Moderate capital expenditures over the next few years should also help keep financing needs and debt growth manageable. Longer-term prospects should continue to benefit from good population growth and the diversified economy of the Greater Toronto Area (GTA).

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Canadian Public-Private Partnerships, which can be found on our website under Methodologies.

This is a Corporate (Infrastructure) rating.