DBRS Asg Rtg of B(H), B, & B(L) to Jean Coutu Group(PJC)Inc.

Dominion Bond Rating Service (“DBRS”) has today assigned ratings of B (high) to the Bank Credit Facilities, B to the Senior Unsecured Debt, and B (low) to the Senior Subordinated Debt of Jean Coutu Group (PJC) Inc. (“Coutu”). The trends are Stable.

The above ratings and trends for Coutu are constrained by:

(1) High debt levels resulting from the purchase on July 31, 2004, of 1,549 Eckerd drug stores from J.C. Penney Company, Inc. for US$2.5 billion (mostly debt-financed); and
(2) The low incremental operating cash flows as post-acquisition U.S. earnings have been weak because: (a) the disruption caused by the sale of Eckerd led to high pharmacist turnover and customer losses, resulting in negative sales trends for both prescription drug sales (“Rx”) and front-store merchandise in the United States. Eckerd store sales have still not increased beyond pre-acquisition levels, although recently there have been improvements (albeit tentative) in sales trends;
(b) the integration of administrative and information technology (I.T.) functions, together with the implementation of Coutu’s systems, took longer than expected due to higher complexity and the much larger size of this acquisition relative to Coutu’s legacy U.S. operation; and
(c) complications arose from the integration of supply chain systems in August 2005.

DBRS notes that in recent months, supply chain performance has begun to improve, changes have been made to the U.S. and overall management teams, and the integration of administrative and I.T. functions has been completed. Therefore, the operating systems are now largely in place to permit U.S. operating results to pick up. With a stabilized customer base, sales and profitability are expected to benefit from continued efforts to improve the merchandise mix, generic and private label penetration, and shrink.

DBRS also notes that Coutu’s financial profile is extremely weak, with very high leverage and low coverage levels including cash flow from operations-to-total debt of 0.09 times. Debt repayment requirements appear manageable, and in the near term, Coutu is expected to maintain compliance with financial covenants in its bank credit facilities. However, the covenant requirements become more demanding over time and Coutu will be challenged to meet the tightening requirements unless there is a material improvement in operating results for the combined U.S. operations (as operating results for the much smaller Canadian segment remain very strong). Should this materialize, credit ratings are likely to improve