DBRS Confirms Loblaw’s Ratings Following Review of Shoppers Drug Mart Acquisition

DBRS has today confirmed the Issuer Rating, Medium-Term Notes and Debentures ratings of Loblaw Companies Limited (Loblaw or the Company) at BBB, its Commercial Paper rating at R-2 (middle) and its Cumulative Redeemable Second Preferred Shares, Series A, rating at Pfd-3, all with Stable trends. This action follows the conclusion of DBRS’s review of the Company’s intended acquisition of Shoppers Drug Mart Corporation (Shoppers) and removes Loblaw’s ratings from Under Review with Developing Implications.

On July 15, 2013, DBRS placed the ratings of Loblaw Under Review with Developing Implications following the Company’s announcement of an offer to acquire the shares of Shoppers for approximately $12.4 billion plus the assumption of approximately $1.2 billion of debt (the Transaction). Loblaw planned to finance the transaction using a combination of equity and incremental debt.

Loblaw stated that it intended to operate Shoppers as a separate business unit and expected both cost and revenue synergies by leveraging loyalty programs, PC Financial, IT, Supply Chain, Marketing, Purchasing, and Private Label Brands. The Company estimated that it could achieve synergies of $300 million by year three.

In its review, DBRS focused on (1) the business risk profile of the combined entity, with integration risks and synergy potential; (2) Loblaw’s financial risk profile on a pro forma basis, including free cash flow generating capacity and willingness and ability to deleverage subsequent to the Transaction; and (3) the Company’s longer-term business strategy and financial management intentions.

DBRS believes that Loblaw’s long-term ratings will continue to be well placed in the BBB rating category as the benefits of the Transaction to the Company’s business profile will more than offset the temporary increase in financial leverage.

DBRS Analysis
(1) Business Risk Profile
The acquisition of Shoppers, Canada’s leading pharmacy, provides Loblaw with a material increase in size and scale, and the leading market share in prescription drugs in Canada. The combined entity would have pro forma sales of over $42 billion. In addition, the Transaction provides Loblaw with greater product diversification as well as a new smaller store format with greater access to urban areas. The Transaction would also offer significant synergy potential (Loblaw estimates synergies to be $300 million by year three, which DBRS believes is achievable) as well as benefits from combining the strong private label brands and loyalty programs of both Loblaw and Shoppers. The Transaction will also offer a strong growth platform for PC Financial.

(2) Financial Risk Profile
In terms of financial profile, DBRS recognizes that the Transaction would result in a meaningful increase in Loblaw’s balance-sheet debt (approximately $4.5 billion) and leverage. Lease-adjusted debt-to-EBITDAR attributable to the retail operations is expected to peak at the time of closing at approximately 3.79 times (x), materially higher than current levels (2.70x for the LTM ended Q2 F2013). The Company will nevertheless generate healthy levels of free cash flow (estimated in the $600 million to $700 million range after dividends).

(3) Outlook
DBRS recognizes that Loblaw possesses the ability to deleverage at a good pace going forward, based on its solid free cash flow generating capacity. DBRS believes that the Company will use such free cash flow primarily for debt reduction over the near to medium term. Specifically, DBRS expects lease-adjusted debt-to-EBITDAR attributable to the retail operations to return below 3.50x, a level that would be considered acceptable for the current rating category, within a reasonable timeframe.

The Company’s intention to deleverage, combined with the notable improvements to its business risk profile, lead DBRS to believe that Loblaw is best positioned in the BBB rating category. Should the Company not deleverage to indicated levels within an acceptable timeframe (12 to 24 months) as a result of more aggressive-than-expected financial management or should the Company experience weaker-than-expected operating performance, the current ratings could be pressured.

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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

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