DBRS Confirms Canadian Tire Ratings at BBB (high), R-2 (high), Stable

DBRS has today confirmed Canadian Tire Corporation, Limited’s (CTC or the Company) Issuer Rating, Medium-Term Notes and Debentures ratings at BBB (high) and its Commercial Paper rating at R-2 (high). All trends remain Stable. The confirmation of the ratings is based on CTC’s stable operating performance across all segments and successful integration and improved leverage subsequent to the acquisition of The Forzani Group Ltd. (FGL Sports), while recognizing mounting pressure on the Company’s retail operations in the near to medium term due to an intensifying competitive environment. The ratings continue to be supported by CTC’s strong brands, national diversification and impressive real estate portfolio. The ratings also reflect tougher competition in Canadian retail, particularly with the expansion and introduction of major U.S. retailers Wal-Mart Stores, Inc., Lowe’s Companies, Inc. and Target Corporation, the potential for disproportionate growth in the riskier financial services business and the pressure for increasing shareholder returns.

The earnings profile of CTC’s retail segment improved modestly in the last 12 months (LTM) ended Q2 2012, benefiting from relatively stable organic operating performance, the inclusion of FGL Sports retail sales and higher gas prices. Canadian Tire Financial Services (CTFS) also improved its operating performance in the same period, as the Company continued to refine its product offerings to support its retail operations despite pressure from regulatory changes. As a result, CTC’s EBITDA improved to approximately $1.1 billion for the LTM ended Q2 2012 from just under $1 billion at year-end 2010.

CTC’s financial profile has remained relatively stable, as a result of its free cash generating capacity and a gradual reduction in debt levels since the acquisition of FGL Sports. Cash flow from operations before changes in working capital continued to track operating income, increasing modestly to $1.2 billion for the LTM ended Q2 2012, while capex increased as CTC undertook store renovations, continued the re-branding of Mark’s Work Wearhouse (Mark’s) and allocated capital to FGL Sports.

The Company’s dividend policy remained consistent, resulting in free cash flow before changes in working capital of approximately $742 million for the LTM ended Q2 2012. CTC used free cash flow to repay indebtedness incurred to complete the acquisition of FGL Sports. As such, balance-sheet debt attributable to the retail operations of CTC was approximately $1.16 billion, resulting in improved lease-adjusted debt-to-EBITDAR of 2.70 times (x), from a pro forma level of approximately 3.0x at the time of the FGL Sports acquisition.

Going forward, DBRS expects CTC’s earnings could be pressured somewhat as competition intensifies in the face of a difficult consumer environment, but the Company’s earnings profile should remain within the range acceptable for the current rating category. Top-line revenue should grow in the low-single-digit range into 2013, based on a modest increase in square footage and flat to modestly negative same-store sales at CTR, combined with low- to mid-single-digit same-store sales growth at FGL Sports and Mark’s. CTFS operating performance should remain relatively stable, based on a modest increase in gross average receivables and relatively stable net credit card write-offs. EBITDA margins in the retail segment could be pressured somewhat as promotional activity increases to help drive traffic in a competitive environment. As such, DBRS believes EBITDA will increase only modestly in the near term.

DBRS believes that CTC will maintain a financial profile commensurate with the current rating category, based on its strong cash generating capacity and relatively stable debt levels. Cash flow from operations should continue to track operating income and remain relatively stable in the $1.1 billion to $1.2 billion range for 2012 and 2013, while capex is expected to increase to the $400 million to $500 million range as the FGL Sports integration continues and CTR stores are expanded and refreshed. DBRS believes dividends will continue to increase in line with policy but should remain modest in proportion to earnings and cash flow. As such, DBRS forecasts that free cash flow before changes in working capital could be in the $450 million to $550 million range in the near term. DBRS believes that CTC will use free cash flow to finance growth opportunities and increase returns to shareholders rather than to repay outstanding debt. As such, DBRS expects that balance-sheet debt and key credit metrics should remain relatively stable in the near term and within the range acceptable for the current rating category.

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

The applicable methodologies are Rating Companies in the Merchandising Industry and Rating Companies in the Services Industry, which can be found on our website under Methodologies.