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, with Stable trends. DBRS has also converted the Company’s Commercial Paper rating into a Short-Term Issuer Rating and confirmed the Short-Term Issuer Rating at R-2 (high), with a Stable trend. The basis for the conversion is that the Company has no Commercial Paper outstanding and no plans to use Commercial Paper going forward. The confirmation reflects acceptable operating performance despite pressure from an intense competitive environment and a relatively stable financial profile. Metro’s ratings continue to be based on its solid market positions in core regions, beneficial locations and diversified formats. The ratings also reflect the intense competition in food retailing, furthered by the emergence of new non-traditional players, particularly in the Company’s core markets of Ontario and Québec.

Metro’s earnings remained under pressure since F2013 through Q3 F2014, as the Company shifted its merchandising strategy early in the fiscal year, investing in pricing to better compete and help protect market share. The change in strategy resulted in improving sales trends through F2014, but negatively affected EBITDA margins. As such, EBITDA declined approximately 2.7% since F2013 to $799 million for the LTM ended Q3 F2014. The Company’s financial profile remained acceptable for the current rating based on the Company’s cash flow generating capacity and moderate financial leverage (i.e., lease-adjusted debt-to-EBITDAR of 2.07x at the end of Q3 F2014) despite increasing shareholder returns. In Q1 F2014 Metro announced a change in dividend policy, increasing its target dividend to 25% of prior fiscal year net earnings from 20%. In addition, the Company used incremental debt to complete share repurchases, resulting in a return toward normal historical balance sheet debt levels (subsequent to the temporary decline in F2013, after proceeds from the sale of Couche-Tard shares were used to repay the Company’s revolving credit facility).

Going forward, Metro’s earnings profile should remain relatively stable over the near to medium term, despite an intense but reasonably rational competitive environment, as new square footage additions in the food retailing industry normalize and food inflation helps top-line growth. Sales are expected to grow in the low- to mid-single-digit range in the near to medium term, based on low-single-digit same-store sales growth and a modest approximately 1% increase in selling square footage. EBITDA margins will remain under pressure as the Company continues to invest in price in order to protect market share, while operating expenses should increase somewhat (i.e., labour, electricity and transportation). As such, EBITDA is expected to remain relatively flat in the $800 million range in the near term.

Metro’s financial profile is expected to remain stable over the near to medium term, based on its cash generating capacity and conservative financial management. Cash flow from operations should track operating income, while capex is expected to increase notably toward the $250 million to $275 million range as the Company invests in renovations, expansions, and approximately ten gross new store openings. Dividends are expected to continue to increase in the near term, with the recent change in dividend policy increasing the annual targeted payout, as well as over the longer term as operating income rises. As such, DBRS believes free cash flow before changes in working capital could be in the $175 million to $225 million range in F2015. Metro is expected to continue to use free cash flow generated and possibly incremental debt to invest in growth (acquisitions) and/or to complete share repurchases. Should Metro’s credit risk profile deteriorate in terms of a decline in operating income and key credit metrics (i.e., lease-adjusted debt-to-EBITDAR toward 2.5x or lease-adjusted EBITDA-to-interest toward 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.

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 web site under Methodologies.

The full report providing additional analytical detail is available by clicking on the link under Related Research at the right of the screen or by contacting us at info@dbrs.com.