DBRS Confirms METRO INC. at BBB and R-2 (high), Stable Trends

DBRS has today confirmed the ratings of METRO INC. (Metro or the Company) at BBB and R-2 (high), with Stable trends. Metro’s ratings and steady performance continue to be supported by the Company’s strong market positions in both Québec and Ontario, its good format diversification between fresh food and discount and its geographic footprint, which includes many prime urban locations.

As expected, Metro’s F2008 operating earnings (before non-recurring items) of $463 million were 5.5% lower year over year (yoy), due to a more competitive operating environment, especially in Ontario, and lower H1 2008 earnings caused by margin pressure stemming from issues related to a new Management Information System and Food Services Warehouse. The Company was able to resolve its operational issues beginning in Q2 F2008, however, and minimize the impact on operating margins, which remained in line with historical levels at 4.3% for F2008. Metro continues to maintain its strong earnings profile in F2009 as same-store sales and earnings benefit from increased volumes, a more rational pricing environment and higher inflation. With resolution of its operational issues and further productivity gains, Metro’s operating margins for the 12 months ended March 31, 2009 (Q2 F2009), improved to 4.8% compared with 4.3% for F2008 and 4.6% for F2007.

Top-line growth is expected to slow somewhat in the near term as inflation moderates. However, DBRS believes Metro will continue to show modest growth in operating income as the Company keeps margins relatively stable through ongoing productivity initiatives, including improvements in shrink, distribution and labour management. Over the longer term, DBRS believes Metro’s strong business profile, combined with the improved private-label program and banner rationalization, will continue to support Metro’s strong earnings profile, keeping the Company well placed in the current rating category.

Metro’s F2008 free cash flow of $218 million was significantly higher than the roughly $100 million that had been expected due to lower capex and working capital usage. Increased free cash flow allowed Metro to fund increased share repurchases of $106 million ($18 million in F2007) and debt repayment of $45 million ($82 million in F2007). Metro’s continued (albeit lower) debt reduction helped keep the Company’s financial profile stable yoy despite the modest drop in operating cash flow. While debt levels have remained unchanged at Q2 F2009 compared with year-end F2008 ($1,012 million), cash flow has returned to historical levels, resulting in a slight improvement of coverage and leverage metrics.

As Metro completes its banner rationalization program and associated store renovations, increased capex should result in lower free cash flow for F2009. However, DBRS expects Metro will continue to manage acquisitions and share repurchases over the near term in order to maintain a relatively stable financial profile. Over the longer term, DBRS expects Metro will continue to generate strong free cash flow, providing the financial flexibility to further strengthen its position in the BBB category.

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

The applicable methodology is Rating Food Retailers, which can be found on our website under Methodologies.

This is a Corporate rating.