Fitch Ratings has affirmed the FA MGT Limited Partnership’s (MGT) CAD305 million 2016 guaranteed senior secured notes at ‘BBB’. The Rating Outlook is Stable.

RATING RATIONALE
The rating reflects MGT’s role as one of two terminal operators serving diversified shipping lines at the Port of Montreal (POM), the primary gateway port for Eastern and Central Canada, albeit with some exposure to competition and labor disputes. MGT’s lack of long-term contracts with shipping lines is somewhat mitigated by the long operating history of the existing shipping customers at the port, coupled with the lack of cost-effective alternatives for serving the Quebec and Ontario markets.

MGT’s flexible cost structure allows it to adjust variable costs in line with declines in shipping volumes to protect EBITDA margins. Leverage remains modest compared with peers, but the bullet maturity introduces refinancing risk to the debt structure, limiting the rating.

KEY RATING DRIVERS

Strong Position; Strategic Port: (Revenue Risk — Volume: High Midrange)

Fitch has revised its assessment of Revenue Risk (Volume) to ‘High Midrange’ from ‘Midrange’ following the publication of its new Transportation Infrastructure Rating Criteria, which assesses volume risk on a five-point scale.

MGT is one of only two container operators at POM, operating two of the port’s four international container terminals. Montreal is the primary port of call for Canada’s largest markets: Quebec and Ontario. Service levels are somewhat limited to eastern Canada, with discretionary U.S. Midwest traffic handled primarily by U.S. East Coast ports. Volumes through the POM are high at 1.7 million 20-foot equivalent units (TEUs) in both 2021 and 2022, respectively. MGT’s franchise strength within the port is strong, handling nearly 879,000 TEUs in 2022, giving it 51% of market share at POM. MGT’s facilities are well utilized but not constrained.

Established Customers, Limited Contracts: (Revenue Risk — Price: Midrange)

MGT’s contracts with shipping lines are generally short-to-intermediate in duration, averaging three to five years. The lack of minimum volume guarantees with shippers exposes revenues to potential volatility; however, contracted price escalation is matched to labor and CPI increases. Fitch believes MGT’s long-term relationships with customers (Hapag-Lloyd, OOCL, Maersk, CMA-CGM) make it likely that shipping lines will continue to renew their agreements.

Modest Capex Requirements: (Infrastructure and Renewal Risk: Stronger)

The current MGT capex projections through 2030 are modest. Maintenance capex is financed through operational cash flows, but MGT has resorted to lease financing for its new equipment purchases, such as new rubber tire gantries (RTGs) and new ship-to-shore cranes (STS) that position MGT to more efficiently handle the largest vessels calling at its facilities.

Fixed-Rate Bullet Debt: (Debt Structure: Midrange)

Debt consists of a CAD305 million bullet private placement fixed-rate bond maturing in 2026. The bullet structure of the debt potentially exposes the operator to refinancing risk. In place of a cash funded debt service reserve account (DSRA), there is a standby LOC equivalent to six months of debt service (interest only).

Financial Profile
MGT benefits from relatively steady operating margins, ranging between 34%-36% during 2019 to 2021 period, reflecting the variable nature of the majority of the costs despite ongoing revenue pressures. The margins improved significantly to 45% in 2022 due to high ancillary revenue, but are expected to return to normal levels going forward. Liquidity is low compared to peers, but is considered adequate together with the six-month DSRA LC.

In Fitch’s rating case, senior P&I debt service coverage ratio (DSCR) averages 2.5x through 2030, which compares favorably to peers. Total debt/EBITDA is consistent with the rating level, falling to a modest 4.2x by 2026.

PEER GROUP
Relevant Fitch-rated peers include Alabama Port Authority (BBB+/Stable Outlook) in the U.S. and DP World Limited (BBB-/Positive Outlook) in Dubai, United Arab Emirates. Alabama is a full port, compared with DP World, which is a global terminal operator. While MGT’s coverage remains high and leverage is modest compared with peers, the bullet debt introduces some refinancing risk to the debt structure, limiting the rating.

RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:

• A continued period of material throughput reduction leading to declines in revenue and operating margins, or additional medium-term borrowing, which lead to an increase in debt/EBITDA above 6.0x on a sustained basis;
• Labor disruptions leading to volume shifts away from Canadian ports, constraining revenues and margins;
• Longer term, competitive pressure from other terminals, leading to volume shifts away from MGT’s Island of Montreal facilities that constrain revenues and margins.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

• Revenue growth and maintenance of operating margins resulting in total debt/EBITDA maintained below 4.0x on a sustained basis.

BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

CREDIT UPDATE
MGT’s volumes grew by 5% in 2022 to 879,000 TEUs following two consecutive years of decline; 13.5% in 2020 and 1% in 2021. The volume declines in 2020 and 2021 were attributed to labor strikes and pandemic-related disruptions.

Volume grew in 2022, but was lower than management’s previous expectations and slightly below Fitch’s rating case forecast of 880,000 TEUs, due to disruptions along the logistic chain, including lack of drayage capacity and some ramifications of labor strikes in 2021. As the new labor agreement was only settled in December 2022, the shippers that had re-routed cargo to Halifax in 2021, were reluctant to return to Montreal during the year. Moreover, the installation of ship-to-shore cranes and POM’s overhaul of one of the berths, led to congestion at the yard, adding to the challenges in bringing the volume back.

MGT’s revenues significantly increased by 38% in 2022 despite volume growth of only 5%, largely driven by an increase in ancillary revenue (such as storage and demurrage charges). Continued disruptions in logistics chains, clogged warehouses and the lack of sufficient truck capacity forced cargo owners to use marine terminals as temporary depots despite the punitive storage costs. The revenues were significantly higher than 2019 levels, as well as Fitch’s base and rating case forecasts for 2022. However, management expects ancillary revenues to return to normalized levels after 1Q23.

MGT’s costs have historically been flexible, adjusting relative to volumes through business cycles and providing for resilient operating margins. Costs remained well managed through the pandemic period, with management successfully adjusting costs downwards through the volatile periods of 2020 and 2021. Fixed costs represent roughly 40% of MGT’s total operating costs (primarily port rent, administration costs, insurance, and equipment leases) and move with inflation.

Variable costs, dominated by labor costs, are closely tied to volumes, and account for the remaining 60%. The variable costs, however, increased by over 20% in 2022, reflecting higher volumes, reduced yard efficiencies and lower labor productivity. Fitch notes margins have remained relatively stable in the 34%-36% range from 2019 to 2021, despite pandemic-related effects, labor disruptions and rail blockades during this timeframe. This margin stability illustrates the resiliency of MGT’s cashflows even during periods of volume stress. The margins, however, improved significantly to 45% in 2022, reflecting higher ancillary revenues.

Labor disruptions have negatively affected MGT’s operations in both 2020 and 2021, exacerbating pandemic-induced volume pressures. After rail disruptions and work stoppages in 2020, Canadian Union of Public Employees (CUPE) and Maritime Employers Association reached a truce, with a pledge to forego further labor stoppages for seven months while the two sides resumed contract talks. This truce period expired with no new agreement in place in April 2021, leading to a strike that resulted in a volume loss of approximately 25,000 TEUs.

The federal government approved legislation in April 2021 to provide for resumption and continuation of operations at POM, while imposing a mediation process for resolving matters in dispute between the parties. The legislation also empowered the mediator-arbitrator to impose arbitration as the process for resolving matters that cannot be resolved through mediation. After several hearings, the federally appointed arbitrator submitted the new collective agreement to Ministry of Labor on Dec 9, 2022. The agreement is for a period of five years but is retrospective commencing from Jan. 1, 2019, and hence, four years have already elapsed. The agreement expires Dec 31, 2023 and the key terms are in line with the expectations.

MGT’s capital program through 2030 is modest and consists of investments to either refurbish existing equipment or purchase replacement equipment, improving MGT’s cargo handling efficiency or reducing operating costs. MGT received two new STS cranes in mid-2021, with the cranes coming online by year end; two additional STS cranes were installed in 2022, for a total of four new cranes. In 2023, MGT will implement optical character recognition technology that will provide real time inventory and provide automatic work instructions directly to equipment operators.

FINANCIAL ANALYSIS
Fitch’s base case adopts management projections through 2030, projecting TEU growth at a CAGR of 0.8% from pre-pandemic levels in 2019 to 2030, while the container handling revenues grow at a CAGR of 3.4% over the same period. The TEUs, which were expected to recover to 2019 levels by 2023 previously, are now expected to reach that level only by 2026.

The recovery has been slower as the shippers that had re-routed a portion of their volumes to Halifax or New York during 2021 were reluctant to return to Montreal until a labor agreement was in place (new agreement was settled in December 2022). In addition, ongoing capex created congestion at the yard. Hence, only normal volume growth of 2.5% per year is expected from 2023 through 2030.

Operating expenses grow at a CAGR of approximately 3.3% during the same period. From 2031 through 2041, TEUs grow at a CAGR of 1.5% per year, while container handling revenues grow at a CAGR of 3.5%. Operating expenses grow at approximately 3.7% per year. Senior P&I DSCR coverage averages 2.8x (minimum of 1.8x) from 2023 to 2030, while Total Debt/EBITDA falls from 5.0x in 2023 to 4.0x by 2026.

Fitch’s rating case assumes TEU’s grow at 0.2% CAGR from pre-pandemic levels in 2019 through 2030, while the container handling revenues grow at an average of 2.8% over those same years. The TEUs, which were expected to recover to 2019 levels by 2023 previously, are now expected to reach that level only by 2028 and grow at a lower rate of 1.2% thereafter.

Operating expenses grow at a CAGR of 2.9% during the same period reflecting lower volumes and variable cost in comparison to the Fitch base case. From 2031 through 2041, TEUs grow at a CAGR of 1.5%, while container handling revenues grow at CAGR of 3.5%. Operating expenses grow at approximately 3.7% per year. Under this case, Senior P&I coverage averages 2.5x (minimum of 1.8x) from 2023 to 2030, while Total Debt/EBITDA falls from 5.1x in 2023 to 4.2x by 2026.
Source: Fitch Ratings