DBRS Confirms Loblaw Companies Limited at BBB, R-2 (middle) and Pfd-3, Stable Trends

DBRS has confirmed the Issuer Rating, Medium-Term Notes rating and Debentures rating of Loblaw Companies Limited (Loblaw or the Company) at BBB, and its Cumulative Redeemable Second Preferred Shares, Series A rating at Pfd-3, all with Stable trends. DBRS also confirmed the Senior Unsecured Debt rating of Shoppers Drug Mart Corporation (Shoppers) at BBB with a Stable trend, based on guarantee by Loblaw. 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 (middle), with a Stable trend. The basis for the conversion is that the Company has no commercial paper outstanding and no current plans to use commercial paper going forward. The confirmations reflect the closing of the acquisition of Shoppers as well as acceptable operating performance in a difficult competitive environment in the core food retail business. In addition, the rating action reflects DBRS’s expectation that the Company will continue with its deleveraging plan set at the time of the Shoppers acquisition, which should result in credit metrics considered acceptable for the current rating by the end of 2015. Loblaw’s ratings continue to be supported by its strong business profile, featuring industry-leading size, scale and market positions in retail and pharmacy across Canada. The ratings incorporate the intense competition in the food retail industry in Canada and the expected decline in financial leverage in the near to medium term, subsequent to the acquisition of Shoppers.

Loblaw’s earnings benefited from the stabilization of the Company’s core food retail business in 2013 and H1 2014, which has performed relatively well in an intense competitive environment, in addition to the full consolidation of Shoppers’ results in Q2 2014. The Company’s financial leverage remains high for the current rating as it continues deleveraging subsequent to the acquisition of Shoppers (which closed March 28, 2014) and the associated increase in balance-sheet debt.

Going forward, Loblaw’s earnings profile should remain stable at a level considered strong for the current rating, despite continuing intense competition in the core food retail business and the newly acquired pharmacy business. DBRS believes that, combined, Loblaw’s and Shoppers’ revenue will increase in the low to mid-single digit range per year in the near to medium term, reaching toward the $45 billion level in the medium term. EBITDA margins should continue to benefit from the consolidation of Shoppers’ higher margin business as well as the achievement of expected synergies and Loblaw’s recent focus on improving efficiency and reducing costs. The improvement in EBITDA margins could be partially offset by lower gross margins in food retail due to rising input costs, which may be difficult to fully pass on to consumers in such a competitive environment. As such, EBITDA should increase toward the $3.7 billion level in the medium term.

DBRS expects that Loblaw’s financial leverage should continue to decline as the Company uses free cash flow to repay debt pursuant to its deleveraging plan following the acquisition of Shoppers. Cash flow from operations should track operating income over the medium term while capital expenditures should remain in the current $1.3 billion to $1.4 billion range as costs related to Loblaw’s SAP implementation are replaced with integration expenditures and investments in renovations, expansions and new store openings (Loblaw and Shoppers). The cash outlay related to dividends is expected to increase above the $400 million level, reflecting current per-share dividends on the new shares issued to complete the Shoppers acquisition. DBRS, therefore, continues to believe that Loblaw will generate free cash flow in the $600 million to $700 million range going forward. Loblaw is expected to use free cash flow in the near term primarily for debt repayment. DBRS forecasts that lease-adjusted debt-to-EBITDAR attributable to the retail operations should return below 3.50 times (x), a level considered acceptable for the current rating, by the end of 2015. Over the longer term, DBRS expects that Loblaw will use free cash flow to complete share repurchases. Should credit metrics improve toward the Company’s stated target (i.e., lease-adjusted debt-to-EBITDAR of 3.0x) as a result of growing operating income and/or continuing debt repayment, a positive rating action could result.

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.

The applicable methodologies are DBRS Criteria: Guarantees and Other Forms of Explicit Support (July 2013), Preferred Share and Hybrid Criteria for Corporate Issuers (Excluding Financial Institutions) (December 2013), Rating Companies in the Merchandising Industry (October 2014) and Rating Entities in the Real Estate Industry (October 2013), which can be found on our website under Methodologies.

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

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.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.