DBRS Confirms METRO INC. at BBB and R-2 (high) with Stable Trends

DBRS has today confirmed the Issuer Rating and Senior Unsecured Debt rating of METRO INC. (Metro or the Company) at BBB and its Commercial Paper rating at R-2 (high), with Stable trends. The confirmation of the ratings recognizes pressure on the Company’s earnings profile in F2013 from an intensifying competitive environment and reflects at least temporary benefits to the Company’s financial profile from its sale of nearly 50% of its ownership interest in Alimentation Couche-Tard Inc. (Couche-Tard; the proceeds of which were used to temporarily repay debt). Metro has announced that it is currently investigating the best use of such cash, a review that includes any possible investments in organic growth, acquisitions or increasing returns to shareholders. Going forward, should the Company’s credit metrics weaken beyond a level considered acceptable for the current rating category (i.e., lease-adjusted debt-to-EBITDAR above 2.5 times (x)) as a result of weaker-than-expected operating performance or more aggressive-than-expected financial management, the ratings could be pressured.

Metro’s ratings continue to be based on its solid positions in its core markets, beneficial locations and diversified formats, while reflecting the intensifying competition in food retailing furthered by the emergence of new non-traditional players, particularly in the Company’s core markets of Ontario and Québec, as well as the Company’s less-developed private labels and high levels of union penetration.

Metro’s earnings profile came under pressure in F2013 as the effects of an intensifying competitive environment in recent years began to show, along with value-conscious consumers challenging top-line growth. Revenue declined modestly through Q3 F2013 versus the same period the previous year as same-store sales growth slowed (+1.5% in Q1 2013, flat in Q2 2013 and -0.9% in Q3 2013) and a number of unprofitable stores were closed. EBITDA margins improved modestly through the first three quarters of F2013 (versus the previous year) based primarily on reduced shrink, improved cost controls and the closure of such unprofitable stores. As such, EBITDA (excluding equity earnings from Couche-Tard) increased to $842 million for the last 12 months ended Q3 F2013 from approximately $822 million in F2012 and $724 million in F2011.

Metro’s financial profile remained conservative and helped keep the overall credit profile adequate for the current rating category. The Company used proceeds from its sale of nearly half of its ownership interest in Couche-Tard to repay amounts drawn on its revolving credit facility. However, any benefits to the Company’s financial profile are expected to be temporary as the Company reviews its potential use of such funds and its optimal capital structure. Free cash flow before changes in working capital declined moderately through Q3 F2013 due to an increase in capital expenditures (capex; primarily for refreshing, expanding and converting the banners of existing stores) and a modest increase in dividends. Free cash flow was used primarily to complete share repurchases.

Going forward, DBRS expects Metro’s earnings profile will continue to be pressured by new store openings from non-traditional market players in the Company’s core regions and continued aggressive pricing behaviour. Top-line revenue should remain relatively flat, based on a decline in same-store sales and a modest increase in selling square footage (0.5% to 1.0% range in F2014). EBITDA margins may be pressured in the near term, as a highly promotional environment could force Metro to consider investing in gross margin in order to help maintain or grow its market share, and stagnant top-line growth will result in a loss of operating leverage. As such, EBITDA is expected to remain relatively flat or decline modestly in the near term.

In terms of financial profile, Metro has the capability to remain stable within the range considered acceptable for the current rating category as it determines its business strategy and optimal capital structure. Cash flow from operations should continue to track operating income, while capex requirements are expected to remain elevated, as Metro invests in refreshing stores and converting Ontario locations to its discount Food Basics banner. Dividends are expected to continue growing at a pace consistent with recent years. DBRS expects that Metro will continue to use its free cash flow (likely in the $250 million range) and incremental debt (including the proceeds from the Company’s sale of its interest in Couche-Tard) to complete share repurchases. That said, should the Company consider participating in the consolidation and mergers and acquisitions in the sector, Metro could use free cash flow generated and incremental debt for this purpose. As such, balance sheet debt and key credit metrics should return to at least normal levels in the near term. Should credit metrics deteriorate beyond levels considered acceptable for the current rating category (i.e., lease-adjusted debt-to-EBITDAR of 2.5x or lease-adjusted EBITDA-to-interest of 8.0x) as a result of weaker-than-expected operating performance or more aggressive-than-expected financial management, the ratings could be pressured.

Notes:
All figures are in Canadian dollars unless otherwise noted.

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

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, which can be found on our website under Methodologies.