DBRS Assigns Provisional Rating of BBB to Dollarama with Stable Trend

DBRS has today assigned an Issuer Rating of BBB to Dollarama Inc. (Dollarama or the Company) and a provisional rating of BBB to the Company’s proposed new Senior Unsecured Notes, both with Stable trends. The ratings are based on the Company’s strong brand and market position in the growing dollar store segment in Canada, proven track record of growth and efficient operations. The ratings also consider the intensely competitive retail environment in Canada, dependence on supply chain to maintain low pricing and relatively low barriers to entry in the segment.

The dollar store retail segment in Canada is highly underpenetrated, with significant growth potential. While competition is intensifying, the dollar store segment remains one of the few retail segments in Canada where demand exceeds capacity. Demand growth is supported by the growing acceptance of dollar stores amongst higher income households, as well as the slower-than-anticipated economic recovery in Canada.

Over the last five years, Dollarama’s revenue has nearly doubled to $2.0 billion, driven by industry-leading comparable store sales, as well as steady store expansion. Comparable store sales have averaged approximately 6% since F2009, based on increasing basket size and customer traffic. Basket sizes have grown due to the introduction of higher price points and debit card implementation. Customer traffic has improved, resulting from a consistently available core offering of products in a well laid-out store format, which makes for a better customer shopping experience relative to its peers. During this period, the Company has increased its store base by almost 50%, to 828 stores, 86% more than its four largest competitors combined in the dollar store segment. This rapid organic growth was facilitated by Dollarama’s cookie-cutter approach to new store development, including real estate selection, store outfitting, and the leasing of all stores.

The volume of goods that Dollarama sources directly from its long-standing, low-cost supplier network allows it to maintain both a strong value proposition and attractive gross margins. EBITDA margins have consistently improved, to 18.9% for the last 12 months (LTM) ended Q2 2014 from 13.8% in F2009, resulting from operating leverage, product mix and productivity improvements. As a result, Dollarama’s EBITDA increased significantly, to $375 million for the LTM ended Q2 F2014 from $150 million in F2009. Return on capital has also improved considerably, to 26.4% in the LTM ended Q2 F2014.

Dollarama’s financial profile is strong for the current rating category based on the Company’s increasing cash-generating capacity and its conservative financial management. Despite the aggressive store expansion, capital expenditure (capex) has remained modest relative to operating income. Free cash flow before changes in working capital has increased to $169 million in the LTM ended Q2 F2014 versus $87 million in F2009. From F2009 until F2012, Dollarama reduced its debt balance by $420 million, using a combination free cash flow and a $272 million equity issuance. Since, the Company has used all of its free cash flow and some incremental debt to repurchase approximately $260 million of shares. As a result of both debt repayment and growth in operating income, lease-adjusted debt-to-EBITDAR, lease-adjusted EBITDA coverage and free cash flow as a percentage of debt have all improved significantly to 2.2x, 10.2x and 19% from 5.7x, 2.6x and 9% in F2009, respectively. DBRS expects the proceeds from the proposed offering of Senior Unsecured Notes will be used to pay down the balance on the Company’s credit facilities such that there is no material change in leverage.

In the near to medium term, DBRS expects Dollarama’s earnings profile to improve within the current rating category as the Company continues to benefit from increased scale resulting from comparable store sales of approximately 4% to 5% and an average annual increase in selling space in the high single digits. DBRS believes comparable store sales will continue to be driven by larger average basket size due to a greater proportion of merchandise sold at higher price points. DBRS expects EBITDA margins will remain in the 19% range as the Company maintains its targeted gross margin of 36% to 37% and the benefits from further productivity initiatives (labour scheduling, point of sale systems, warehouse management) could be offset by increases in wages and transportation costs. As a result, DBRS believes EBITDA should increase to approximately $500 million in F2016.

DBRS expects Dollarama’s free cash flow-generating capacity to continue to increase, based on growing operating income, modest capex requirements and dividend increases in line with earnings growth. DBRS believes Dollarama will generate a total of approximately $500 million of free cash flow over the next three years. As the Company is not expected to make any acquisitions in the near to medium term, DBRS expects free cash flow, along with some incremental debt will be used to repurchase shares such that credit metrics remain stable. However, should lease-adjusted debt-to-EBITDAR increase above 2.5x, resulting from weaker-than-expected operating income and/or more aggressive 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.