DBRS Confirms Sears Canada Notes at BBB, Discontinues Bank Debt Rating

DBRS has today discontinued Sears Canada Inc.’s (Sears Canada or the Company) Revolving Term Facility (RTF) rating and confirmed the Company’s Issuer and Medium-Term Notes (MTN) ratings at BB and BBB, respectively.

Sears Canada’s secured, three-year, $200 million RTF expired in December 2008. The RTF had been solely used to support the Company’s offshore merchandise purchasing program and has been replaced by a US$120 million letter of credit facility.

When the Company’s three-year RTF was established in 2005 as a secured facility, Sears Canada’s unsecured MTN noteholders were also granted security in all assets of the Company and its material subsidiaries on a pari passu basis to the RTF providers. At that time, DBRS’s ratings were amended to reflect the change in status of the MTN, from an unsecured to secured basis and thereafter the MTN were referred to as Secured Notes. With non-renewal of the RTF (which expired in December 2008), all security interests have now been discharged and the MTN or Secured Notes have reverted to their original unsecured structure, per the Trust Indenture dated December 22, 1998. The MTN are no longer governed by financial covenants, however MTN noteholders still benefit from a negative pledge and covenants limiting the sale of assets.

The confirmation of the remaining ratings is based on the view that the above changes do not materially affect the overall credit risk profile of the Company. Although the MTN are now unsecured, their priority position remains unchanged – the majority of Sears Canada indebtedness is now on an unsecured basis with no major secured creditor ahead of the MTN noteholders. Sears Canada’s total debt at January 31, 2009 was $364.6 million, consisting mostly of MTN ($300 million maturing in 2010), with the remainder made up of joint venture debt and capital leases.

Secondly, DBRS continues to believe that Sears Canada’s creditors can expect a full recovery on a going-concern basis. DBRS’s view is based on our previously completed recovery analysis – see DBRS report dated September 19, 2008. In our analysis, Sears Canada’s strong asset recovery value was estimated based on: 1) the Company’s brand and license values; 2) its real estate portfolio; 3) its relatively low debt levels; and 4) its short bond maturities (2010). In addition, DBRS believes that the near-term recovery would be enhanced by the Company’s large cash balances ($819.8 million at January 31, 2009 – excluding restricted amounts). DBRS notes however, that in addition to the elimination of financial covenants, negative covenants limiting distributions are also no longer present. While this increases the risk of funds being redirected to majority shareholder Sears Holdings Corporation (Sears Holdings), DBRS remains comfortable that the recovery value excluding cash balances would still provide sufficient coverage to support the RR1 rating (i.e. 90% -100% recovery).

Lastly, Sears Canada continues to perform relatively well despite the current economic environment and continued decline in performance at majority shareholder Sears Holdings Corp. For the 52 weeks ended January 31, 2009 Sears Canada reported operating EBITDA (before unusual items) of $517.0 million on sales of $5.733 billion, compared with operating EBITDA and sales of $521.6 million and $5.845 billion respectively for the comparable prior period. Same store sales were down 1.6% compared to last year on a comparable basis. DBRS notes that Sears Canada reported an 11.3% increase in EBITDA through Q3 F2009, however an increasingly difficult retail environment in Q4 helped reverse those gains for the full year. While results were down slightly for the year, Sears Canada’s performance remains very acceptable when considering the decline in consumer spending and overall retail sector results.

In contrast, Sears Holdings Corporation’s performance continues to deteriorate. For the year ended January 31, 2009, comparable store sales declined 8% in 2008, resulting in full year revenues declining to US$46.8 billion from US$50.7 billion in the prior year. Sears Holdings realized net income (excluding unusual items) of US$215 million compared with US$806 million in the prior year.

While Sears Canada’s ratings continue to be driven by: 1) the influence of struggling majority shareholder Sears Holdings on the day-to-day decision-making and operation of Sears Canada (i.e., cost-cutting and reduced capital investment); and 2) the possibility that Sears Holdings could remove significant cash flow and/or capital from Sears Canada, there is not necessarily a direct relationship between the ratings of the two companies. At this time DBRS continues to believe Sears Canada’s BB Issuer Rating adequately reflects the risk associated with Sears Holdings. However, DBRS will continue to monitor the declining performance and management strategy at Sears Holdings for potential impact on Sears Canada’s ratings over the longer-term.

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

The applicable methodology is Rating Merchandisers, which can be found on the DBRS website under Methodologies.

This is a Corporate rating.