DBRS Confirms Finning International at A (low), Stable Trends

DBRS has today confirmed the Issuer Rating and Senior Debentures and Medium-Term Notes rating of Finning International Inc. (Finning or the Company) at A (low), as well as the Company’s Commercial Paper rating at R-1 (low). The trends are Stable. The ratings reflect Finning’s strong business profile, although DBRS acknowledges that the financial profile is weak for the A (low) rating category.

As anticipated (please see the rating report dated January 23, 2012), Finning’s financial profile has further weakened due to the execution of the fully debt-funded acquisition of Bucyrus International Inc. (Bucyrus) in the second and third quarters of 2012. As a result, adjusted debt-to-capitalization increased to 57.4%, adjusted gross debt-to-EBITDA rose to 2.83 times (x) and cash flow-to-debt deteriorated to 0.29x on a trailing 12-month basis as at September 30, 2012.

The confirmation and Stable trend reflect DBRS’s view that, although currently outside the A (low) range for financial metrics, Finning has yet to benefit from the full-year results of Bucyrus segments on a trailing 12-month basis due to a delay in acquisition completion. The South American and Canadian Bucyrus units were acquired two and five months later, respectively, than originally projected and were expected to contribute meaningfully to the cash flow-to-debt coverage and leverage metrics had they been acquired on time.

The continued assimilation of the acquired units should serve to gradually improve leverage and coverage metrics over the coming quarters, with full-year Bucyrus results anticipated to be fully integrated in the third quarter of 2013. At that time, DBRS also anticipates further improvement based on Finning’s stated objectives of curtailment of working capital investment, reduction of capital expenditures and commitment to attaining a 35% to 45% net debt-to-capital ratio. DBRS notes that these efforts are consistent with historical experience when elevated debt-to-capitalization was brought down to target. As such, DBRS expects that the financial metrics will continue to improve on a sequential quarterly basis, while noting that trailing 12-month results will not begin to show the recovery anticipated in the last rating report until the second quarter of 2013. Full recovery toward the A (low) range is not anticipated until the end of fiscal 2013.

DBRS also notes that Finning’s superior business profile is a primary rating consideration. Finning benefits from its relationship with its original equipment manufacturer supplier (Caterpillar Inc.), has a diversified business mix, commands a strong parts and service franchise and is an overall market leader. The recent addition of Bucyrus further enhances Finning’s business profile, because it enhances its product diversity mix with the addition of a wide range of products, expands sales territories and significantly extends the ability to bundle products for a customer.

In terms of earnings, Finning’s operating results for the first three quarters of 2012 were strong relative to the same period in 2011. Revenues improved by 18.6% and EBIT by 16.8%, although overall EBIT margin was 0.1% lower. Revenues grew the most in its Canadian segment, aided by resolution of the bulk of its enterprise resource planning (ERP) related issues, which plagued Finning up to this point. Revenues in its South American and U.K. segments expanded 13.2% and 9.3%, respectively. Product support revenue was the main revenue growth driver and grew 20.0%, augmented by Finning’s enhanced oil sands servicing capabilities in Canada and dominant market share in South America. New equipment sales expanded 17.4% and were a major contributor to growth, underpinned by construction and mining activity. EBIT margin showed no improvement when compared to the first three quarters of 2011. Selling, general and administrative (SG&A) as a percentage of revenue remained elevated relative to plan.

The near-term revenue outlook remains mixed among geographic regions, with stable Canadian and Chilean economic environments partially offset by challenging conditions in the United Kingdom and Argentina. The new equipment sales environment is also less upbeat, as some miners and builders are choosing to delay capital investment. At the same time, DBRS believes that the outlook for the more stable product support business remains robust due to fundamentals such as a growing equipment population base, an aging customer fleet, greater customer equipment utilization and also due to Finning’s enhanced service offering. The Company’s commitment relating to SG&A reduction, expansion of higher-margin revenue sources and ongoing operational excellence initiatives should help support EBIT margins. In 2013, Finning should be able to achieve low-to-mid single-digit sales growth, and at least maintain the historical 5% to 8% EBIT margins.

DBRS anticipates that operating and free cash flows will trend higher as a result of (i) stronger sales due to continued Bucyrus segment integration, (ii) reductions in working capital as ERP glitches are principally resolved and as Finning focuses on reducing uncommitted inventory and (iii) dampened capital expenditures, partially due to completion of service facility investments. As such, DBRS estimates that Finning will generate at least $150 million in net free cash flow in 2013 (assuming flat revenue growth and existing EBIT margins) and potentially apply it toward debt reduction, further strengthening its balance sheet position consistent with the commitment to reduce the net debt-to-total capital ratio to the target range of 35% to 45%.

DBRS maintains the expectation for Finning to show continuous improvement in its credit metrics through 2013 and to achieve adjusted debt-to-EBITDA of approximately 2.5x and adjusted cash flow-to-debt of approximately 28% at the end of the second quarter of 2013. DBRS reiterates that failure to attain improvement in the financial profile would likely result in negative rating action.

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

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 to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is the Rating Companies in the Capital Goods Dealership Industry, which can be found on our website under Methodologies.