DBRS Confirms Ratings of 407 International Inc.

DBRS Limited (DBRS) confirmed 407 International Inc.’s (407 or the Company) Senior Bonds rating at “A,” Junior Bonds rating at A (low) and Subordinated Bonds rating at BBB. All trends are Stable, supported by the solid long-term economic fundamentals of the catchment area and 407’s sound cash flow generation and good operating efficiency, but tempered by the Company’s sizable debt burden and leverage intentions.

Traffic volumes, as measured by vehicle kilometres travelled (VKT), grew by 4.9% in 2016 and, accompanied by higher toll rates, led to a 13.2% increase in revenue. Operating expenses decreased by 7.7% for the same period, mainly attributable to lower customer litigation expense and lower tolling service contract expenses, partially offset by higher system operation expenses, resulting in EBITDA growth of 17.3% to $985.0 million. The senior debt service coverage ratio (DSCR), including shadow amortization, was 2.4 times (x), while junior and senior interest coverage was 3.0x. Traffic growth continued in the first nine months of 2017 (9M 2017) with VKT up by 2.7%, reflective of a 0.9% increase in the number of trips and an 1.8% increase in average trip length compared with the corresponding period last year. No congestion payments are expected to be incurred in 2017. For the full year, the Company projects a 10.5% increase in revenue and 7.5% increase in operating expenses, resulting in a projected 11.0% increase in EBITDA.

In September 2017, 407 reduced the available limit under its credit facilities to $465.0 million from $1.0 billion. As at September 30, 2017, the credit facilities were drawn to $302.0 million compared with $602.0 million at the beginning of the year. DBRS anticipates that the credit facilities will be fully drawn to $465.0 million by the end of 2017, representing a net yearly reduction of approximately $137.0 million in the utilization of the credit facilities. Combined with the $250.0 million Series 17-A1 Senior Notes issued in March 2017 and the $500.0 million Series 17-A2 Senior Notes issued in September 2017, net incremental borrowings are expected to be $613.0 million as at YE2017, higher than the $500.0 million of annual incremental leverage originally expected by DBRS.

The Company plans to pay down draws on the credit facilities with future capital market issuances and to increase its leverage by up to $535.0 million for 2018. After 2018, the Company plans to increase its leverage by up to $500.0 million per year. DBRS notes that the credit facilities generally have not been used for liquidity purposes but were frequently fully drawn pending bond issuances, and adequate liquidity in the form of balance sheet cash and reserves will be maintained. Should the Company decide to cancel its credit facilities, DBRS does not expect the cancellation of these credit facilities to materially and negatively affect the Company’s liquidity, given the Company’s solid cash flow generation and its good access to capital markets.

Current income taxes amounted to $66.6 million in 2016 and $114.3 million during 9M 2017. After incorporating the effects of the additional debts and income taxes, the cash-based senior DSCR with shadow amortization was 2.3x as at Q3 2017, whereas the cash-based senior and junior DSCR was 2.8x, both of which continue to support the ratings. Along with its plan to gradually increase leverage, 407 still expects to maintain the senior indenture DSCRs and senior and junior cash DSCR (net of cash income taxes) well above 1.7x and 2.0x, respectively, agreed upon with DBRS at the current rating levels. For 2018, DBRS estimates the senior DSCR with shadow amortization at approximately 2.2x, based on the Company’s forecasts. DBRS notes that the credit is comfortably positioned within the current rating levels. Negative rating pressure could result from a marked deterioration in financial metrics or if 407 were to increase its leverage at a pace materially quicker than expected without a commensurate improvement in traffic levels. A rating upgrade is considered unlikely.

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 principal methodology is Rating Public-Private Partnerships, which can be found on dbrs.com under Methodologies.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.