DBRS Confirms Cara Operations at B, Trend Stable

DBRS has today confirmed the Secured Second Lien Notes rating of B and Issuer Rating of B of Cara Operations Limited (Cara or the Company). The trends are Stable. Pursuant to DBRS’s methodology on leveraged finance, the recovery rating of RR4 has been confirmed on the Company’s Secured Second Lien Notes. Cara’s ratings continue to be supported by the strength of its iconic brand portfolio and the improving revenue stability from its franchisee network. The ratings also reflect the volatile and competitive nature of the restaurant industry.

During F2009, Cara began its conversion into a franchise model from a corporate-owned structure. As such, Cara’s earnings profile in the last two years has undergone a recalibration process as its earnings become primarily driven by royalty income and franchisee fees rather than by revenue from corporate-owned stores (resulting in lower reported revenues when compared with previous years prior to conversion).

In F2011, system sales grew by 4%, mostly driven by new restaurant openings as same-restaurant sales (SRS) grew by only 0.4% due to the soft consumer environment for most of the year. As part of the shift toward the franchise model, reported revenue in F2011 was lower than what was reported in previous years. That said, EBITDA margins (excluding conversion income) improved significantly to 13.4% in F2011 from approximately 9% a year earlier, largely the result of the reduction in cost of goods sold, SG&A and overhead costs associated with operating under a franchise model. In terms of financial profile, Cara’s cash flow from operations continues to cover capex and dividends. Capex requirements continued to decline to a level that is less than 50% of the Company’s cash flow from operations. Dividend payments remained relatively stable, in line with previous years. As such, Cara continued to generate positive free cash flow during the year. However, some funding of discontinued operations and potential acquisition-related costs led to a modest increase in gross debt, thereby resulting in a slight increase in Cara’s key credit metric of lease-adjusted debt-to-EBITDAR.

Going forward, DBRS expects Cara’s earnings to benefit from a slowly improving consumer environment and a steadier revenue base in the near term. System sales are expected to increase in the mid-single digits in F2012, based largely on new store openings (the majority of which will be franchises) and some SRS improvement on the basis of positive pricing. DBRS expects EBITDA margins to further improve as a result of continued improvement in operating leverage, as well as a moderation in input cost inflation during F2012. In terms of financial profile, DBRS expects Cara’s free cash generating capacity to improve from the completion of the Company’s franchise conversion. As such, improving EBITDA, combined with expected debt reduction, should result in an improving lease-adjusted debt-to-EBITDAR in the near to medium term.

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

The applicable methodologies are Rating Companies in the Merchandising Industry and DBRS Criteria: Rating Leveraged Finance, which can be found on our website under Methodologies.