DBRS Confirms Loblaw at BBB and R-2 (middle), Trend Revised to Stable on Long-Term Rating

DBRS has today confirmed Loblaw Companies Limited’s (Loblaw or the Company) long-term debt ratings at BBB and its Cumulative Redeemable Second Preferred Shares, Series A rating at Pfd-3, and revised the trends to Stable from Negative. At the same time, DBRS has confirmed the Company’s short-term rating at R-2 (middle) with a Stable trend.

The rationale for revising the long-term trend to Stable is as follows: On March 11, 2009, DBRS confirmed Loblaw’s ratings and only revised the trend to Stable from Negative on the short-term rating. We were encouraged by Loblaw’s results for the second half of 2008, but chose to proceed with caution and to maintain the Negative trend on the long-term ratings. DBRS needed to see a longer than two-quarter period of stabilization before revising the trend to Stable, given the fact that the recovery followed an exceptionally long period of deterioration for Loblaw (almost four years – 2004 to the middle of 2008). The action on the short-term trend reflected DBRS’s view that Loblaw’s liquidity profile had stabilized from a challenging period in 2008 due to successful financings and improvement in cash flow that all but eliminated any refinancing risk for the near to medium term (see DBRS’s March 11, 2009, press release for greater detail).

At that time, DBRS also stated that it expected Loblaw to continue to focus on cost efficiencies and control label performance and to invest significant levels of capital in IT and supply chain infrastructure over the next couple of years. DBRS felt that Loblaw had gained some traction with its new management structure and initiatives, and was cautiously optimistic about the Company’s ability to deliver steady credit metrics (lease-adjusted gross debt-to-EBITDAR close to current levels) going forward. DBRS then stated that it would consider revising the long-term trend to Stable after another two quarters of stable performance.

With the release of H1 2009 results on July 24, DBRS notes that sales grew by 2.9% (driven almost entirely by same-store sales) as the Company completed pricing adjustments that aimed to improve its value perception with customers and also benefited from a high level of food inflation during the period. The EBITDA margin also benefited from a more rational competitive environment, cost control/efficiency improvement initiatives and food price inflation – 5.86% for the first half of 2009 (vs. the historic low of 5.00% for H1 2008, and 5.44% for H2 2008). As such, EBITDA increased to $817 million in the first half of 2009 from $678 million year over year.

DBRS believes that the management changes and strategic initiatives made in early 2008 have proved successful in stabilizing the business. Loblaw has been able to keep market share almost level and deliver reasonable revenue growth while improving margins for a full year now. The performance over the past year has led to a significant improvement in key credit metrics – lease-adjusted gross debt-to-EBITDAR for the 52 weeks ending June 20, 2009 is now 2.8 times (x) (compared with 3.1x for 2008, and 3.7x for the 52 weeks ending June 14, 2008), a level that is well within the BBB rating category for Loblaw. With solid performance for four quarters in a row, DBRS is prepared to revise the trend on its long-term ratings for Loblaw to Stable from Negative.

DBRS is prepared to take this action despite the fact that operating performance and credit metrics may actually moderate over the near term due to the effects of food price deflation, a weak economic environment, and intense competition. We believe a more stable Canadian food retailing sector, combined with the initiatives taken by Loblaw over the past year and a half to address its internal problems, have strengthened the Company and positioned it to withstand a more challenging environment within the current rating category. DBRS also acknowledges that Loblaw’s intention to increase its capital budget for the remainder of the year (to $1 billion from previous guidance of $750 million) will use much of the free cash flow that could have been used to reduce net debt further. That said, DBRS has not necessarily been seeking improvement in credit metrics through debt reduction, particularly if incremental investment improves Loblaw’s competitiveness and creates value for the Company. With regard to Loblaw’s announcement to acquire T&T Supermarket Inc. (T&T), DBRS views this as slightly positive. The approximately $200 million cash acquisition (T&T has no debt) will thrust Loblaw into the Asian food market and provide it with the opportunity to enhance growth and diversification without significantly increasing financial leverage (Loblaw has approximately $800 million of cash on hand).
Notes:
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.