Morningstar DBRS Confirms the Issuer Rating of 407 International Inc. at "A," Trends Remain Stable

DBRS Limited (Morningstar DBRS) confirmed 407 International Inc.'s (407 or the Company) Issuer Rating at "A" as well as the credit ratings on its Senior Bonds at "A," Junior Bonds at A (low), and Subordinated Bonds at BBB. All trends remain Stable. The credit ratings continue to be supported by the long-term economic fundamentals of the service area and 407's adequate liquidity position. The Stable trends reflect the Company's improved financial outlook with reasonable buffer to withstand a conceivable economic downturn scenario and the potential negative impact of the new Hwy. 413 project.

KEY CREDIT RATING CONSIDERATIONS
The Company reported 2,535.4 million vehicle kilometres travelled (VKT) in 2023, representing a 14.6% growth on a year-over-year (YOY) basis yet still falling 8% below the 2019 level. Total revenue and total EBITDA in 2023 reached $1,495.5 million and $1,283.9 million, respectively, essentially fully recovered to the 2019 levels. For Q1 2024, the Company reported total VKT of 514.2 million, 7.1% higher than the same period last year. Further supported by the toll increases effective on February 1, 2024, total revenue reached $329.8 million during Q1 2024, representing a YOY quarterly growth of 11.8%.

With the Company's implementation of toll increases in February 2024, Schedule 22 payments will be applicable in 2025, with any amounts to be paid in the following year, starting in 2026. Such payments will gradually decline as traffic volume grows at a modest pace. At the same time, Morningstar DBRS expects the Company will implement measures to mitigate future Schedule 22 payments.

Despite the toll rate increases in February 2024, the observed traffic volumes thereafter seem to have demonstrated a low price elasticity. Morningstar DBRS currently assumes that 407's total revenue will be 114% of the 2019 level in 2024 and total traffic volume will fully recover to the pre-pandemic levels around 2027.

In Morningstar DBRS' view, the financial benefit of the 2024 toll increases will likely outweigh the Schedule 22 payments, improving the Company's financial outlook. However, it may also put the Company in a more vulnerable position to unexpected traffic shocks, which would not only result in lower revenue but also significant Schedule 22 payments at the same time. Morningstar DBRS stress tested key financial metrics under a downside scenario negating any S22 mitigation measures and assuming total annual VKTs to remain 10% below the 2019 level between 2024 and 2026 before reverting to the management projection for 2027 and onward. While key financial metrics become weaker in the stress test (2025 being the weakest year), they remain supportive of the credit ratings.

On March 21, 2024, Ontario's Minister of Transportation announced that the federal and Ontario provincial governments had agreed to continue with the Hwy. 413 project, pending final approval of the environmental assessment by the Province of Ontario (rated AA with a Stable trend by Morningstar DBRS). The Hwy. 413 project represents a major undertaking by the government to catalyze the economic development in the Northwest GTA and relieve congestions in the region. Based on discussions with the management, Morningstar DBRS understood that the Company has performed a thorough analysis of the potential impact of Hwy. 413 on its performance. At the current time, Morningstar DBRS does not expect the net opening year (mid 2030s) impact of Hwy. 413 to be material.

CREDIT RATING DRIVERS
Absence of substantial leverage reduction on a sustainable basis and given the inherent volume risk of the project, a credit rating upgrade is unlikely. Negative credit rating pressure may result from a marked deterioration in Morningstar DBRS' expected traffic outlook, insufficient liquidity, or a leverage increase faster than what can be justified by sustainable traffic levels.

FINANCIAL OUTLOOK
The Company still intends to maintain the senior debt service coverage ratio (DSCR), including shadow amortization, above 1.7 times (x) and the senior and junior cash interest coverage ratios above 2.0x (both net of cash income taxes), which represent the thresholds Morningstar DBRS considers suitable for the current credit rating levels. Morningstar DBRS currently expects the Company's key financial metrics to remain above these thresholds, assuming no additional debts, which will be subject to a credit rating affirmation test. Morningstar DBRS considers the Company's subordinated debt as having characteristics of equity for the purpose of rating the Senior and Junior bonds.

CREDIT RATING RATIONALE
The credit ratings are underpinned by (1) the economic strength of the catchment area, (2) a lack of major competition, (3) legislative protection to enforce toll collection, (4) healthy liquidity, and (5) the requirement for a credit rating affirmation before issuing new debt. The challenges include (1) the inherent volatility of toll roads and elevated uncertainties in future growth, (2) a tradition that favours dividend distribution over debt containment, (3) potentially constrained tolling flexibility and Schedule 22 payments, (4) the inflation-linked debt instruments, and (5) refinancing risk.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030.

RATING DRIVER AND FINANCIAL RISK ASSESSMENT (FRA)

(A) Weighting of Rating Drivers
In the analysis of the Company, the Rating Drivers listed in the methodology (Part Two - Rating Volume-Based PPPs) are considered in the order of importance.

(B) Weighting of FRA Factors
In the analysis of the Company, the following FRA factor listed in the methodology (Part Two - Rating Volume-Based PPPs) was considered more important: minimum DSCR.

(C) Weighting of the BRA and the FRA
In the analysis of the Company, the FRA carries greater weight than the Rating Drivers.

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Public-Private Partnerships (April 15, 2024),
https://dbrs.morningstar.com/research/431193

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186, which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodology has also been applied:
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024), https://dbrs.morningstar.com/research/427030

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

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 under Related Documents or by contacting us at info-DBRS@morningstar.com.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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