DBRS Confirms Sobeys at BBB, Stable Trend

DBRS has today confirmed Sobeys Inc.’s (Sobeys or the Company) Senior Unsecured Debt rating at BBB with a Stable trend. The confirmation follows the upgrade a year ago from BBB (low). The upgrade reflected improved operating performance and financial management. Today’s confirmation acknowledges the improvements achieved by the Company and the fact that these improvements continue.

Given the economic downturn through 2009, Sobeys has worked hard to strengthen its market position in the face of intense competition and food price deflation. While grocers are resistant to economic downturns, they still must aggressively use promotions and price matching to manage market share. This will make it challenging for Sobeys to increase same-store sales growth and operating margins over the near term. Even so, DBRS expects some further progress in F2011 in growing revenue despite competition, deflation and a soft economy. Sobeys maintains a good variety of selling formats/banners and is well diversified geographically to meet changing customer trends and the growing number of non-traditional competitors.

Sobeys continues to invest in its store base to improve its competitive position. While the total number of stores has changed little over the years (similar number of store openings and closings), the retail selling footage has increased modestly. As most stores are leased, the investment has been focused mainly on leasehold improvements, expansions and format changes with a view to boost store appeal to customers.

In doing so, the Company is choosing to invest in raising the productivity of the existing store base. These changes have been successful at the Sobeys bannered stores. This was also helped by improvements in its warehouse/distribution operations, such as the Company’s new, virtually automated distribution center in Vaughan, Ontario.

However, success appears less clear across other key banners. For example in Ontario, the Company has been converting smaller IGA stores to Foodland stores, and Price Chopper stores will be replaced with the new FreshCo stores. At this point, it seems that more work needs be done by Sobeys to produce more consistent results across all of its main banners. If successful in this endeavour, the Company should see improved market share and profitability. In addition, if leverage is eased, there could be positive pressure on the credit ratings over the next year or two.

Sobeys’ market share and same-store sales growth have improved EBITDA and margins. Higher cash flow from operations, combined with stable capital expenditures, resulted in positive free cash flow. This resulted in gross lease-adjusted debt-to-EBITDAR of 2.51 times and gross lease-adjusted cash flow-to-debt of almost 24% for F2010.

DBRS expects growth in sales and margins to hold over the next few years as the Company realizes on its investments in the store base. This, coupled with economic improvements and some food price inflation, should lead to sales growth of 3% to 3.5% and relatively stable margins in F2011. DBRS also expects free cash flow to remain positive, which could be used to reduce leverage.

Note:
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.