DBRS Confirms Superior Plus LP/Superior Plus Income Fund at BBB (low) and STA-3 (low)

DBRS has confirmed the Senior Secured Notes rating of Superior Plus LP (Superior or the Partnership) at BBB (low) with a Stable trend, and the stability rating of Superior Plus Income Fund (the Fund) at STA-3 (low).

The confirmations reflect the implementation of more conservative financial policies over the past 18 months, including lower targeted debt-to-EBITDA (senior debt: 1.5 to 2.0 times (x) and total debt 2.5 to 3.0x compared with 1.5 to 2.5x and 2.5 to 3.5x, previously) and payout ratio (below 90% versus 100% previously). Additionally, Superior’s key credit metrics have improved following the debt reduction in late 2006. Total debt-to-EBITDA improved to 2.98x and senior debt-to-EBITDA improved to 1.93x in 2007 from 3.35x and 1.95x, respectively, in 2006. Concurrently, the Fund’s payout ratio (DBRS-defined) declined to 84% in 2007 from 93% in 2006. In February 2008, the Fund announced a modest 4% increase to its monthly distribution to $0.135 per unit or $1.62 per unit annualized (from $0.13 per unit or $1.56 annualized). DBRS expects that the Fund will continue to meet its target payout ratio of below 90% following this distribution increase.

The Fund has also taken initiatives to maintain and grow its distributable cash flows. In August 2007, its subsidiary, ERCO Worldwide (ERCO, specialty chemicals business) proceeded with the US$95 million project to convert its Port Edwards potassium/chloralkali facility from a mercury-based process to membrane technology, with start-up scheduled in the last half of 2009. The project is designed to significantly improve process efficiency and increase the plant’s capacity by approximately 30%. The Partnership’s natural gas and electricity retailer, Superior Energy Management (SEM; 5% of operating distributable cash flow (operating DCF) in 2007), also entered the newly deregulated British Columbia natural gas market and the Ontario electricity market, both of which present significant long-term growth opportunities. Finally, DBRS expects that the Fund will not alter its fundamental financial and strategic objectives as a result of the Canadian federal government legislation that results in the taxation of existing income trusts, including the Fund, beginning in 2011. The Fund’s ability to continue its distribution at current levels beyond that point could be negatively affected by the change in tax legislation as modified by Fund-specific tax considerations. Superior’s subsidiaries have approximately $415 million to $430 million of unutilized tax pools that could be used to reduce its taxes payable in future years. DBRS would view any such reduction in future distributions as a one-time event, with the subsequent analytical focus on the stability and sustainability of the revised distributions.

Despite these positive factors, Superior faces some near-term challenges. Its key Superior Propane and ERCO segments accounted for a combined 79% of 2007 operating DCF. Superior Propane’s results can be negatively affected by reduced demand as a result of warmer-than-normal winter weather and high propane costs (correlated to the price of crude oil). In addition, ERCO’s results were hampered by reduced sodium chlorate demand (74% of ERCO’s 2007 sales) due to significant pulp mill closures in 2005 and 2006, although results improved modestly in 2007 and DBRS expects prices and volumes to remain stable in 2008. The Fund’s cost of equity capital has increased following the cumulative 37% distribution cut during March/April 2006 that reduced its unit price. This has reduced the Fund’s financial flexibility with respect to growth opportunities, at least over the near term. Finally, Superior previously indicated that it will increase the amount of operating leases that it uses to finance much of its transportation equipment (replacing currently-owned assets) at Superior Propane and Winroc (building materials distributor), a process it began in 2007. To the extent that material increases occur, this would offset some of the improvement in credit metrics that has taken place since the late-2006 debt reduction. However, DBRS expects that any increase would be relatively modest over the medium term.

Although results in Q1 2008 deteriorated slightly from Q1 2007, primarily due to the timing of maintenance capex and lower wholesale business profits at Superior Propane, as well as lower profits at Winroc from the slowdown in new residential construction in the United States and Ontario, DBRS expects the Fund to meet its 2008 plan through the remainder of the year. Furthermore, DBRS expects that the significant degree of diversification within the Fund and its segments will continue to support its ability to generate stable cash flows and maintain its reasonably strong credit metrics and conservative payout ratio over the medium term, which are appropriate for a business with its level of volatility.

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