DBRS Confirms Cara Operations Limited at B, Stable Trends

DBRS has today confirmed the Senior 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 Recovery Ratings for Non-Investment Grade Corporate Issuers,” the recovery rating of RR4 has been confirmed on the Company’s Senior Secured Second-Lien Notes. The ratings confirmation is based on Cara’s relatively stable operating performance and steady financial profile throughout F2012 despite the persistence of a sluggish consumer environment. The ratings continue to be supported by its strong market position and the strength of its brand portfolio in Canada. The ratings also take into consideration the Company’s high level of financial leverage as well as the competitive and cyclical nature of the restaurant industry.

The consumer environment remained soft in Cara’s core markets throughout F2012. System sales, after adjusting for an additional week in F2011 and the impact of restructuring activities related to Kelsey’s, increased modestly by 2.4% in F2012. This was driven by new store openings (6.1%), which were offset partially by negative same-restaurant sales (SRS, -1.9%) as pricing initiatives were not enough to offset the decline in customer count. EBITDA margins (excluding conversion income) under the franchisee model have begun to settle at a higher equilibrium (approximately 15% in F2012) relative to previous years thanks to lower costs associated with cost of goods sold, SG&A and overhead. As such, EBITDA (excluding conversion income) increased by over 3% in F2012 versus F2011.

In terms of financial profile, Cara generated modest free cash flow before changes in working capital, benefitting from declining capex requirements and modest dividend payments in F2012. Stable debt levels, combined with improved operating performance, led to an improvement in Cara’s key credit metrics (i.e., lease-adjusted debt-to-EBITDAR, EBITDAR coverage and free funds flow to debt) within the current rating category during F2012.

In F2013, DBRS expects system sales to increase in the low-single digits, driven largely by new store openings as SRS is expected to remain flat for the year. In the nearer term, DBRS expects new store openings will continue to be the primary driver of growth, but the Company should also begin to benefit from positive SRS as the consumer environment slowly improves. EBITDA margins are expected to improve slightly in F2013, owing to further cost reductions related to the tail end of the Company’s franchise conversion as well as a beneficial input cost environment. As such, EBITDA should continue to grow in line with system sales growth.

In terms of financial profile, DBRS expects that the completion of the majority of franchise conversions at the end of F2013 will allow Cara to improve its free cash flow generating capacity, thanks largely to a steadier revenue stream as well as lower capital requirements. As such, Cara should generate higher levels of free cash flow before changes in working capital in F2013, which DBRS anticipates will largely be utilized toward debt reduction as no major acquisitions are expected.

Should Cara further improve its key credit metrics through the combination of continued growth in operating income and/or reduced leverage, a positive rating action may result in the near term.

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 and DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers, which can be found on our website under Methodologies.