Canadian agricultural company Coopérative féderée de Quebec (CFQ) has seen its rating downgraded this week by the Dominion Bond Rating Service (DBRS). The ratings had been placed “Under Review with Negative Implications” on 28 February this year.

In a press release, DBRS explained that there are five predominant reasons for the downgrading:

“[Firstly] Olymel, a subsidiary of CFQ, entered into an agreement to acquire the fresh pork division of Premium Brands for C$88m, which will appreciably weaken CFQ’s balance sheet. The purchase is funded with C$40m of bank debt and C$50m from the sale of a minority stake in Olymel to a Sociééy générale de financement du Quebec (SGF). SGF’s investment and support is viewed favourably as it will require no interest or principal repayment initially. However, SGF’s investment has a fixed term of seven years and is therefore being treated as debt.

“[Secondly] CFQ’s degree of leverage has risen with the acquisition of Premium brands and any recovery of balance sheet strength will likely take time as capital expenditures are expected to rise to the C$45m range for the next few years and will utilize most available internal cash flow.

“[Thirdly] Effort will be required to successfully integrate the acquisition, which will raise CFQ’s exposure to a volatile industry and present greater export risks. However, there seems to be sizeable potential to achieve greater earnings with the plant which had F2000 sales of C$240m but weak profitability.

“[The fourth reason is that] most of CFQ’s divisions are highly cyclical and produce modest earnings on average, with thin profitability despite improvements over the past few years. Results for F2000 (ended October 31) were disappointing and below budget as EBIT fell 37% to C$33.7m due to a cyclical downturn in various businesses.

“[and lastly] the overall company size is relatively small versus US competitors, which are striving for better access to domestic markets. A consolidated Canadian food retail industry is also pressuring margins.”

DBRS added however that there are considerable strengths in the company itself, which should buoy its credit rating. Earning fluctuations should be stabilised with the benefits driven from divisional diversification, which will also serve to boost the competitive position of Olymel.

“CFQ is attempting to improve operations and returns by growing the higher margined pork exports and efficiencies,” said DBRS.

The ratings were reviewed as follows:

Rating              Trend     Rating Action Debt Rated
BBB (low)         Stable     Downgraded Senior Unsecured Term Notes
R-2 (middle)      Stable     Downgraded Commercial Paper