TEXT-S&P revs Transcontinental outlook to negative
Overview -- We are revising our outlook on Montreal-based Transcontinental Inc. to negative from stable. -- We base the outlook revision on our view of the ongoing headwinds the company faces in the medium term, with possible declines in both organic revenue and profitability given challenging industry fundamentals. -- We are also affirming our ratings on the company, including the 'BBB' long-term corporate credit rating. -- The negative outlook reflects Standard & Poor's view that Transcontinental could continue to experience declining organic revenue and margin pressure in the medium term. Rating Action On Sept. 21, 2012, Standard & Poor's Ratings Services revised its outlook on Montreal-based Transcontinental Inc. to negative from stable. At the same time, Standard & Poor's affirmed its ratings on the company, including its 'BBB' long-term corporate credit rating. The outlook revision reflects our view of the ongoing headwinds the company faces, with possible continued declines in organic revenue and profitability given challenging industry fundamentals. Transcontinental's operating performance was below our expectations in the nine months ended July 31, 2012, with reported revenue and adjusted operating profit declining 2.5% and 15.5%, respectively, on an organic basis, compared with the same period in 2011. We believe that soft economic conditions in the past few years have accelerated the digital substitution of content and advertising from print, which will continue pressuring the company's print and publishing-related businesses in the medium term. Rationale The ratings on Transcontinental reflect Standard & Poor's assessment of the company's satisfactory business risk profile and intermediate financial risk profile (based on our criteria). We base our business risk assessment on Transcontinental's leading market position in various segments of the Canadian printing and publishing industries. We believe this is partially offset by the company's participation in the challenging printing and publishing sectors. These industries are facing secular declines and pricing pressure because of industry overcapacity due to digital migration of printing and advertising. Our financial risk assessment reflects the company's solid credit protection measures and moderate financial policies. Transcontinental is the largest printer and leading publisher of consumer magazines in Canada, as well as the fourth-largest printer in North America. Canada remains the company's primary market, generating 87% of revenue in fiscal 2011 (ended Oct. 31). Company operations break down into two main segments--printing and media: -- Printing consists of printing newspapers, retail flyers, magazines, educational books, catalogues, and marketing products. Excluding intersegment eliminations and other activities, this sector represented 68% of revenue and 85% of reported adjusted operating income for the nine months ended July 31, 2012. -- Media consists of publishing magazines, community newspapers, and books; door-to-door distribution of advertising materials; digital assets; and marketing products and services using new communication platforms. This segment made up the balance of revenue and reported adjusted operating income. Media has been particularly hard hit this year with a reduction in revenue and reported adjusted operating income of 4.8% and 41.3%, respectively, on an organic basis for the nine months ended July 31, 2012, compared with the same period in 2011. Given lower profitability, the company recorded an asset impairment charge of C$180 million related to goodwill in the Media segment. In March 2012, Transcontinental completed an asset swap with Wisc.-based Quad/Graphics Inc. (BB+/Negative/--), valued at about US$85 million, by closing its acquisition of Quad/Graphics' Canadian business. As part of the transaction, the company sold its Mexican operations and a portion of its black and white book printing business destined for U.S. export to Quad/Graphics in September 2011. We view the transaction positively as it boosts the company's revenue base and provides for cost-saving opportunities. Transcontinental has indicated that it expects the transaction to increase EBITDA by about C$40 million over a two-year period, with C$20 million coming in the 12 months following closing. Our base-case scenario incorporates our expectation that Transcontinental's revenue could increase in the low-to-mid single-digit percent range in the next year, based largely on the contribution of acquisitions, namely the Quad/Graphics Canadian business and transactions completed in the media segment. While we believe that the EBITDA margin will remain pressured in the medium term, it should stabilize somewhat next year because of synergies attained with the Quad/Graphics integration. Furthermore, we expect free cash flow to remain positive, which should allow for additional debt repayment. Transcontinental's revenue increased 4.0% in the nine months ended July 31, 2012, compared with the same period in 2011, because of acquisitions. Still, organic revenue was down 2.5% in this period due to declines of 1.3% and 4.8%, respectively, in printing and media. The company's reported adjusted operating margin (before amortization) decreased to 15.3% in the nine months ended July 31, 2012, from 17.4% in the same period last year, because of weakness in both the printing and media segments, largely due to the impact of lower organic revenue. The company's credit protection measures (adjusted for operating leases, preferred shares [50% of which is treated as debt], and nonrecurring charges) remained in line with the ratings for the 12 months ended July 31, with adjusted debt to EBITDA of 2.2x largely unchanged year-over-year because debt repayment was offset by lower EBITDA. We are expecting leverage to improve to between 1.5x-2.0x in 2013 based on lower debt and higher EBITDA. Liquidity The company has strong liquidity in our view, with positive free cash flow and availability under its C$400 million revolving credit facility due February 2017. Transcontinental's liquidity position fluctuates significantly from quarter to quarter because of the seasonal nature of revenues and cash flows. In accordance with our criteria, relevant aspects of Transcontinental's liquidity are as follows: -- We see liquidity sources over uses to be in excess of 1.5x for the next two years; we expect net sources to be positive even with a 30% drop in EBITDA; -- We believe that the company will maintain at least a 30% EBITDA cushion on its financial covenants, which include a maximum net debt-to-EBITDA ratio and minimum EBITDA interest coverage ratio; -- Due to what we view as Transcontinental's good discretionary cash flow generation and revolver availability, we believe it could absorb high-impact, low-probability adverse business developments; -- Transcontinental appears to have good banking relationships and we believe it has a generally high standing in the capital markets; and -- The company displays prudent financial risk management, in our view. Outlook The negative outlook reflects Standard & Poor's view that Transcontinental might experience continued declining organic revenue and margin pressure given difficult industry fundamentals. We could lower the ratings if Transcontinental's operating performance remains soft or if we believe secular risks have increased to an extent that changes our view of the company's business risk profile or if debt leverage approaches 2.5x. Alternatively, we could revise the outlook to stable if Transcontinental demonstrates sustainable improvement in its operating performance, while maintaining adjusted debt to EBITDA between 1.5x-2.0x. Related Criteria And Research -- Methodology and Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Transcontinental Inc. Outlook Revised To Negative To From Corporate credit rating BBB/Negative/-- BBB/Stable/-- Ratings Affirmed Preferred stock Canada scale P-3(High) Global scale BB+ Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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