DBRS Assigns Provisional Issuer Rating of B to Cara Operations

DBRS has today assigned a provisional Issuer Rating of B to Cara Operations Limited (Cara or the Company). As well, DBRS has assigned a provisional B rating to Cara’s proposed $200 million issue of Senior Secured Second-Lien Notes (the Notes), based on a RR4 recovery rating. The Notes will rank behind a proposed $175 million new credit facility (with a first-priority lien) that will replace the existing $350 million current credit facility. The provisional ratings will be confirmed on the successful completion of the refinancing plan discussed below. The ratings will be reassessed if the refinancing plan is not completed as described. The Issuer Rating is supported by the following factors.

Cara is the largest full-service restaurant operator and the third-largest restaurant operator in Canada. The Company has transformed itself over the last six years from a highly diversified food-service company by divesting most of its non-restaurant businesses, including Second Cup Limited, Air Terminal Restaurants, Summit Food Service Distributors and Cara Airline Solutions. This leaves the family restaurant operations (679 locations) as the core business. Cara has recently centralized the operations to support the five banners: Swiss Chalet (194), Harvey’s (251), Milestones (42), Montana’s (88) and Kelsey’s (103). The restaurant portfolio is mostly in Ontario and the group offers a diverse set of menus. Some brands are quite well known, creating loyalty and equity value. Using its centralized operating platform to provide common support functions, the Company is now in a position to increase the number of restaurants, including locations out west and in Atlantic Canada. The expansion plans include the use of franchisee restaurants to create stable royalty earnings streams and limit the amount of growth capital needed. Most new sites will be leased and the franchisees must fund a large portion of the start-up costs. With this, the composition of earnings and cash flow will shift, with less emphasis on consolidated corporate-owned restaurants and more on the royalty fees, rents, supplies, etc., it receives from the franchisees. The latter type of income tends to be more stable. In fact, the Company is currently converting a number of existing corporate-owned restaurants into franchise sites. This will be mostly complete this year.

The Company’s efforts to reduce its size and diversification over the years so that it can focus on a core segment have created long-term opportunities and short-term challenges. The key longer-term opportunity is to take advantage of the fact that there are few competitors in the restaurant sector that have the same combination of scale, efficiencies, banner diversification and brand equity. The common platform makes it readily scalable, with increasing margins. The main near-term concerns pertain to the fact that (1) the divesting has lowered earnings and cash flow and (2) the funds from the divesting only partially reduced the leverage incurred when the Company went private in 2004. This situation will continue over the next several years until the Company can grow the size of its restaurant base. This, coupled with the fact that the remaining core business is quite sensitive to economic conditions, means that until conditions improve and the base grows, Cara will have an elevated financial risk profile. Hence, maintaining near-term liquidity during this period will remain very important. Successful execution of the business plan and managing the financial risk will require full support from management and the board of directors. As a private company, the board is controlled by the owners. DBRS has inquired about governance practices and its dividend policy, and it appears that good governance will continue to be the norm.

The Notes are part of a larger refinancing plan to revise Cara’s capital structure. The refinancing includes (1) entering into a new credit facility that amends and restates the current credit facility (the new credit facility assumes a successful $200 million Note issue); (2) the issuance of $200 million in Notes; and (3) the termination of a portion of existing interest rate swap agreements. All three are to take place concurrently on the closing of the Note offering. This would allow the Company to repay the current credit facility.

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.