DBRS Assigns a Provisional Rating of BBB (low) to Crombie REIT, Stable Trend

DBRS has today assigned a provisional Issuer Rating of BBB (low) with a Stable trend to Crombie Real Estate Investment Trust (Crombie or the Trust). DBRS notes that the Issuer Rating reflects the credit quality of debt (i.e., senior unsecured) that ranks below the Trust’s property-specific secured debt.

Crombie owns and manages a portfolio of grocery- and drugstore-anchored retail properties, a substantial number of which (49.6% of total annual minimum rent on a pro forma basis) are leased to Sobeys Inc. (Sobeys; rated BBB (low) with a Stable trend). The Trust was established in 2006 through the transfer of an initial portfolio of properties from certain subsidiaries of Empire Company Limited (Empire or the Company). Empire, a holding company, currently owns a 42.1% non-controlling ownership interest in Crombie on a pro forma basis. Empire also has a 100% ownership interest in Sobeys, the second-largest food retailer in Canada, and other investments in real estate.

DBRS notes that while the common ownership and strong connection between Sobeys and the Trust’s operations closely align their interests, the credit risk profiles of the entities do not necessarily have to be the same or move in tandem with each other. This view is supported by the strength of Crombie’s real estate portfolio regardless of its tenant profile. In addition, Empire’s minority ownership in Crombie limits its influence on the Trust’s financial policy. Therefore, a rating change at either Sobeys or Empire would not necessarily result in a rating change for Crombie.

Since its inception in 2006, Crombie has achieved steady earnings growth driven by a series of property acquisitions from its strategic relationship with certain affiliates of Empire and from third-party vendors. In addition, Crombie’s earnings profile has benefited from the quality and defensive nature of the Trust’s grocery- and drugstore-anchored retail properties, and the long-term tenancy of the Trust’s major tenant, Sobeys. Crombie has also displayed a record of consistently prudent financial management.

On July 24, 2013, Crombie entered into a transformational agreement to acquire a portfolio of 68 Western Canadian retail properties from Sobeys for an aggregate purchase price of just over $1 billion (including transaction costs; the Transaction). Sobeys is expected to acquire these properties from Safeway pending final approval under the Competition Act. As part of the Transaction, the 68 Safeway properties to be acquired by Crombie will be leased back to Sobeys. DBRS believes the Transaction will enhance Crombie’s asset quality as many of the properties are located in high-barrier-to-entry urban markets; it will also expand the Trust’s presence in new and existing Western Canadian markets and increase the size and scale of the Trust’s portfolio (17.5 million square feet (sq. ft.) from 14.5 million sq. ft.). The Transaction also will extend Crombie’s lease term to maturity to 12.2 years from 10.5 years, thereby further improving the stability of earnings and cash flow going forward. DBRS estimates that pro forma EBITDA will increase to approximately $220.2 million on an annual basis in 2013.

Crombie is expected to fund the Transaction, totalling just over $1 billion (including transaction costs), with $375 million of equity ($225 million issued to the public and $150 million issued to Empire) and $639 million of debt ($564 million to be drawn on a $600 million bridge loan facility and $75 million of convertible debentures). DBRS expects Crombie will refinance the bridge loan facility with either new mortgages and/or senior unsecured debentures. DBRS estimates pro forma debt-to-gross book value (GBV) assets (fair value) will be 51.6% as at June 30, 2013. In addition, pro forma EBITDA interest coverage (including capitalized interest) is estimated to be 2.33 times. DBRS believes Crombie’s key credit metrics will be consistent with the BBB (low) rating category following the completion of the Transaction.

The provisional investment-grade rating is based on Crombie’s mid-size portfolio of stable retail properties, long-term leases under favourable terms, improved geographic diversification and its strategic relationship with Sobeys and Empire. The rating is limited by Crombie’s tenant concentration with Sobeys, moderate exposure to secondary or tertiary markets, leasing challenges at its more volatile enclosed shopping centre segment and a high level of secured debt as a proportion of total debt.

The stable outlook reflects DBRS expectation that the Trust will continue to pursue portfolio growth by focusing on acquiring new grocery-anchored plazas and freestanding stores from Empire, Sobeys and third-party vendors in Canada’s top 36 markets in a financially balanced manner. Crombie’s management expects to acquire on average $100 million of properties from its strategic Empire/Sobeys relationship annually. In terms of financial profile, DBRS expects Crombie’s debt-to-GBV assets ratio (fair value) to return closer to 50% primarily through equity issuance and/or convertible debenture conversions. Correspondingly, coverage ratios should increase to above 2.40 times, a level that is better placed within the BBB (low) rating category.

A negative rating action could result from: (1) weaker operating and earnings performance and/or higher financial leverage, such that EBITDA interest coverage falls below 2.20 times, (2) and/or significant deterioration in Sobeys’ credit risk profile. On the other hand, a positive rating action would likely be the result of: (1) a material increase in portfolio size, (2) improved tenant diversification and/or (3) a decrease in financial leverage that results in a sustained improvement in EBITDA interest coverage above 3.00 times.

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 Rating Limited for use in the European Union.

The applicable methodology is Rating Entities in the Real Estate Industry, which can be found on our website under Methodologies.