DBRS Confirms Loblaw at BBB, R-2 (middle) and Pfd-3, Stable Trends, Following the Creation of Choice Properties 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 and Choice Properties Real Estate Investment Trust’s (the REIT) announcement earlier today that the REIT has filed and obtained receipt for two preliminary prospectuses in respect of its initial public offering (IPO) of trust units and a concurrent public offering of two series of senior unsecured debentures. DBRS has assigned an Issuer Rating of BBB with a Stable trend to the REIT (see separate press release).

DBRS believes that the terms and conditions of the final transaction are substantially consistent with those contemplated when DBRS reviewed Loblaw’s proposed plan and subsequently confirmed Loblaw’s ratings on December 6, 2013.

The REIT will indirectly acquire through Choice Properties Limited Partnership (the LP), a portfolio of 425 properties totalling 35.3 million square feet of gross leasable area, which is primarily retail focused and comprises a geographically diverse mix of stores, shopping centres, warehouses and office buildings. DBRS estimates the aggregate market value of the properties being acquired from Loblaw is in the $7 billion range.

On closing and going forward, it is expected that Loblaw will hold a significant majority ownership interest in the REIT through ownership of REIT units, as well as all of the Class B limited partnership units of the LP (which are economically equivalent to and exchangeable for units of the REIT). The Company believes that as the REIT’s key tenant, this structure will allow it to retain a high degree of operational flexibility. In addition, Loblaw will hold all of the outstanding Class C limited partnership units of the LP. In conjunction with the offering, George Weston Limited will purchase $200 million of units from the REIT at the IPO price.

Loblaw will also receive notes from the REIT which are senior unsecured debt of the REIT and will rank pari passu with all future senior unsecured indebtedness of the REIT. Concurrent with the IPO, the REIT is expected to offer senior unsecured debentures, the proceeds of which are expected to be used to repay a portion of the indebtedness owing to Loblaw. Loblaw is expected to use such proceeds to repay its own maturing indebtedness.

DBRS believes that this structure effectively maintains Loblaw’s current credit ratings because of the Company’s clear intent to continue to own and control its real estate while using intercompany notes to maintain consolidated leverage levels while effectively transferring an appropriate proportion of financial leverage to the REIT.

Loblaw’s ratings continue to be supported by its strong market positions, 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 the intensifying competition. DBRS expects top-line revenue will grow in the low-single digits the near term, based on a modest increase in square footage and flat 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 Supercentres and Target stores) and the Company continues to invest in infrastructure upgrades. As such, DBRS expects EBITDA (on a comparable basis) should remain relatively 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 on a consolidated basis should remain in a range acceptable for the current rating category.

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.