DBRS Confirms Canadian Tire at BBB (high) and R-2 (high), Stable Trends, Following the Announced Intent to Create a REIT

DBRS has today confirmed the Issuer Rating, Medium-Term Notes and Debentures ratings of Canadian Tire Corporation, Limited (CTC or the Company) at BBB (high), and its Commercial Paper rating at R-2 (high), all with Stable trends. This rating action follows CTC’s announcement on May 9, 2013, of its intention to create a real estate investment trust (REIT) to acquire a majority of the Company’s owned real estate and to sell units of the REIT to the public by way of an initial public offering (IPO). CTC intends on retaining a significant majority ownership interest in the REIT, in the range of 80% to 90%.

DBRS has reviewed CTC’s proposed plan in which the Company would contribute to the REIT approximately 18 million square feet (sq. ft.) of its total of approximately 25 million sq. ft. of owned real estate assets. Based on CTC’s estimates, the initial assets contributed have a current market value in the $3.5 billion range. The REIT’s real estate portfolio will consist predominantly of Canadian Tire Retail (CTR) stores, Canadian Tire-anchored retail developments and one distribution centre.

Based on the terms of the proposed plan, the REIT will issue equity and debt to CTC along with cash raised from the IPO 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. The proposed structure reflects management’s desire to maintain CTC’s current credit ratings. DBRS believes the proposed plan will be effective in preserving key credit metrics (i.e., debt-to-EBITDA adjusted for leases, intercompany interest and distribution income) in the range appropriate for the current rating category.

The REIT would be designed to meet appropriate standards for management, governance and financial structure with leases reflecting market rates and terms. The Company believes the proposed plan will increase its financial flexibility while it pursues new growth opportunities organically and through acquisition, while retaining control of the REIT and therefore a high degree of operational flexibility as the REIT’s key tenant.

CTC’s current ratings continue to be supported by its iconic brand and national diversification. The ratings also reflect the high level of, and intensifying competition in Canadian retail, potential for disproportionate growth in the riskier financial services business and the continued pressure for growth and increasing returns to shareholders.

The confirmation also reflects DBRS’s view that CTC’s earnings profile should remain in the range acceptable for the current rating category in the near term, despite intensifying competition. DBRS expects top-line revenue will remain relatively flat in the near term, based primarily on flat-to-negative same-store sales and only a modest increase in square footage at CTR and low-single-digit same-store sales growth at FGL Sports and Mark’s Work Wearhouse. The operating performance of Canadian Tire Financial Services is expected to remain relatively stable, based on modest improvements in gross average receivables and relatively stable net credit card write-off rates. EBITDA margins should remain under pressure as CTC could be forced to increase its use of promotional pricing to help drive traffic as competition intensifies. As such, DBRS expects that EBITDA (on a comparable basis) should remain relatively flat in the near term.

In terms of financial profile, DBRS believes that CTC will be within the range commensurate with the current rating category, based on financial leverage subsequent to the spin-off of the REIT and the Company’s cash flow generating capacity. Going forward, DBRS believes that the Company will use free cash flow to finance growth opportunities and/or increase returns to shareholders. Should credit metrics deteriorate as a result of weaker-than-expected operating performance or more aggressive-than-expected financial management, CTC’s ratings could be pressured.

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 CTC, 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 methodologies are Rating Companies in the Merchandising Industry, DBRS Criteria: Commercial Paper Liquidity Support Criteria for Corporate Non-Bank Issuers and Global Methodology for Rating Banks and Banking Organisations, which can be found on our website under Methodologies.