DBRS Confirms Loblaw at BBB, R-2 (middle) and Pfd-3, Stable Trends, Following the Announced Intent to Create a REIT

DBRS has today confirmed the Issuer Rating, Medium-Term Notes and Debentures of Loblaw Companies Limited (Loblaw or the Company) at BBB, its Commercial Paper at R-2 (middle) and its Cumulative Redeemable Second Preferred Shares, Series A at Pfd-3, all with Stable trends. DBRS also confirmed the Issuer Rating and Notes & Debentures of George Weston Limited (GWL) at BBB, its Commercial Paper at R-2 (high) and its Preferred Shares at Pfd-3, all with Stable trends (see separate press release).

These rating actions follow Loblaw’s announcement on December 6, 2012, of its intention to create a real estate investment trust (REIT) to acquire a significant portion of the Company’s owned real estate assets and to sell units of the REIT to the public by way of an initial public offering (IPO). Subject to receiving regulatory approval, the REIT is expected to be listed on the Toronto Stock Exchange and Loblaw intends to retain a significant majority ownership interest.

DBRS reviewed Loblaw’s proposed plan and held subsequent discussions with Loblaw’s management team. According to the proposed plan, Loblaw will contribute approximately 35 million square feet (sq. ft.) of its total 47 million sq. ft. of owned real estate assets. Loblaw estimates that its initial contribution of assets to the REIT will have a current market value in the $7 billion range. The REIT’s real estate portfolio will be largely retail focused and comprise a geographically diverse mix of stores, shopping centres, warehouses and office buildings.

Based on the terms of the proposed plan, the REIT will issue equity and debt to Loblaw in exchange for the real estate assets to be contributed by the Company. The intercompany notes will be senior unsecured debt of the REIT and rank pari passu with all future senior unsecured indebtedness of the REIT. This structure reflects management’s desire to maintain Loblaw’s current credit ratings by seeking to effectively transfer an appropriate proportion of its financial leverage to the REIT at the time of the IPO. DBRS believes the proposed plan is designed to adequately offset the effect of substantially higher operating leases on the financial risk profile of Loblaw (i.e., keep lease adjusted debt-to-EBITDAR appropriate for the current rating category).

As a standalone real estate-focused entity, the REIT will have a dedicated senior management team with the intent to maximize the value of the Company’s real estate portfolio, including commanding fair market rents from its tenants. Loblaw believes the proposed plan will create the opportunity to unlock value for both Loblaw shareholders and prospective unitholders, while retaining a degree of operational flexibility for Loblaw, as the REIT’s key tenant.

Loblaw’s ratings continue to be supported by its strong market position, large scale, national diversification and industry-leading private labels. The ratings also continue to reflect the high level of, and intensifying competition in, Canadian food retailing.

The confirmation also reflects DBRS’s view that Loblaw’s earnings profile should remain in the range acceptable for the current rating category, despite intensifying competition and a difficult consumer environment. DBRS expects top-line revenue will remain relatively flat in the near term, based on a modest increase in square footage and flat-to-negative same-store sales. EBITDA margins should remain under pressure as Loblaw could be forced to increase its use of promotional pricing to help drive traffic as competition intensifies (particularly with new openings of Wal-Mart Supercenters and Target stores) and the Company continues to invest in infrastructure upgrades. As such, DBRS expects EBITDA (on a comparable basis) will decline moderately or, at best, remain flat in the near term.

In terms of financial profile, DBRS believes that Loblaw will remain within a range commensurate with the current rating category based on the Company’s free cash flow generating capacity and moderate financial leverage. Although the Company has the potential to improve its credit metrics by applying free cash flow and cash on hand to debt reduction, DBRS believes that Loblaw may use these sources of cash to invest in growth and/or return value to shareholders over the longer term. As such, DBRS expects key credit metrics should remain in a range acceptable for the current rating category.

DBRS will review all aspects of the transaction upon closing. Should the proposed transaction close on terms and conditions that are not substantially in accordance with those outlined in the proposed plan provided to DBRS and/or Loblaw or the transaction experience material adverse changes, DBRS will consider the actual terms and a rating action could result.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Companies in the Merchandising Industry (May 2011), which can be found on our website under Methodologies.