DBRS Confirms Sobeys at BBB with a Stable Trend

DBRS has today confirmed the Senior Unsecured Debt rating of Sobeys Inc. (Sobeys or the Company) at BBB with a Stable trend. The Company’s earnings profile began to stabilize through F2011, following a period of significant growth and improved performance that had resulted in a rating upgrade in September 2009. Sobeys continues to benefit from its national diversification and improving market position despite facing intense competition and a challenging consumer environment.

Net sales increased 3.4% to nearly $15.8 billion in F2011 (53 weeks) from $15.2 billion in F2010 (52 weeks). Adjusting for the additional week in F2011, total sales growth was 1.3%, based on a same-store sales increase of 0.2% and a net increase in retail selling space of 587,000 square feet. The softness in sales growth was primarily the result of real deflationary pricing caused by high levels of promotional activity in response to intense competition. EBITDA margins nevertheless remained steady at 4.8% as improved efficiency helped offset softer same-store sales growth and rising costs. The above factors combined to result in a 2.79% increase in EBITDA to $763 million in F2011.

In terms of the Company’s financial profile, its cash flow from operations continued to track earnings, increasing from $584 million in F2010 to $624 million in F2011. Capex levels increased significantly as Sobeys undertook property development initiatives (with the goal of subsequent sale or leaseback transactions); major efforts to remodel, refresh and re-brand stores; and automation initiatives at certain distribution centres. As such, free cash flow before changes in working capital was modestly negative in F2011. The above factors combined to increase gross lease-adjusted debt-to-EBITDAR to 2.65 times (x) at the end of F2011 from 2.51x at the end of F2010.

Going forward, DBRS believes the Company’s earnings profile should remain stable over the longer term but will be challenged in F2012 as rising input costs and volatile commodity prices combine with intense competition to pressure margins. DBRS expects top-line revenue to increase in the low to mid-single-digit range over the near to medium term, based primarily on inflationary pricing. Margins should come under pressure through F2012 as it may be difficult to completely pass on rising input costs to the consumer given the current economic environment. As such, DBRS expects the Company’s EBITDA to remain flat in F2012.

In terms of the Company’s financial profile, DBRS forecasts cash flow from operations should continue to track earnings and remain steady in F2012 at approximately $600 million. Capex is expected to remain high as Sobeys continues toward the completion of significant store investment initiatives. Free cash flow before changes in working capital should, therefore, remain modestly negative in F2012 before returning to positive levels in F2013. DBRS believes that the Company’s credit metrics should remain stable through F2012. A deterioration in credit metrics (i.e., lease-adjusted debt-to-EBITDAR approaching 3.0x) as a result of weaker-than-expected performance or more-aggressive-than-expected financial management could result in pressure on the current rating.

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

The applicable methodology is Rating Companies in the Merchandising Industry, which can be found on our website under Methodologies.