DBRS Confirms Canadian Tire at A (low) and R-1 (low)

DBRS has today confirmed the Medium-Term Notes and Debentures ratings of Canadian Tire Corporation, Limited (CTC or the Company) at A (low) and its Commercial Paper rating at R-1 (low). All trends are Stable. The confirmations reflect the fact that CTC management took measures to protect the Company’s credit profile while it went through a very difficult economic downturn. As a result, notwithstanding the slippage in its operating and financial performance, CTC held its metrics within ranges that continue to support the current ratings. While the Company’s decline over the last two years is disappointing, it has come after years of growth in its core retailing group and its credit card portfolio. DBRS expects that between internal changes and a somewhat improved economic outlook, the Company’s performance should return to prior levels through 2011. DBRS believes that CTC’s good brand name, market position and prudent management should keep it well positioned as consumer spending and employment improve.

Overall in 2009, the Company experienced softer performance across the group. Canadian Tire Retail (CTR), Canadian Tire Petroleum (CTP) and Mark’s Work Warehouse (Mark’s) all saw lower earnings with the economic downturn, unseasonable weather and the shorter year (52 vs. 53 weeks). Canadian Tire Financial Services (CTFS), including Canadian Tire Bank (CTB), saw its loan portfolio grow but also experienced higher loan losses. Management responded by cutting overhead costs and improving the retail supply chain (the EBITDA margin is now back over 10%). It also preserved capital by reducing capex and inventories.

Going forward, DBRS expects modest growth in retail sales and better loan portfolio returns with lower loan losses. As a result, CTC revenue, EBITDA and cash flow from operations should grow this year and next. With capex limited to $280 million to $300 million, free cash flow should grow and be used to strengthen the balance sheet. In the longer term, the Company needs to improve its return on invested capital to above 10% by making existing assets more productive. Examples of CTC’s drive to achieve greater productivity are (i) the plan to increase retail sales per square foot, with particular focus on stores operating below their potential, and (ii) the plan to revitalize its legacy automotive business under a new group president.

CTC liquidity is good, as a number of alternative sources of funds exist. This access to alternative financing options will be important as there is debt coming due, as well as on-demand retail deposits at CTB, along with a discretionary securitization program. The Company’s liquidity is supported with funds from cash on hand, positive free cash flow, a $1.17 billion committed bank facility, supporting an $800 million commercial paper program (none outstanding), as well as access to retail and broker deposits. The $300 million debt maturity this year will be repaid using cash on hand and thereafter CTC’s debt schedule is very manageable.

While the Company has benefited from growing diversity in its operations, this diversity has in turn raised the level of operational complexity, which elevates risk. If the economy remains challenging and the Company’s performance stalls, this risk could be a potential challenge to manage. CTR could see a decline in same-store sales and margins, and CTFS could see little growth in receivables as consumers reduce credit card usage. Should credit metrics deteriorate (i.e., adjusted debt-to-EBITDAR rises much above 2.6 times) due to weaker operating performance or higher leverage, the ratings and/or trends would be pressured.

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.