DBRS Confirms METRO INC. at BBB after It Announces Acquisition of The Jean Coutu Group Inc.

DBRS Limited (DBRS) confirmed the Issuer Rating and Senior Unsecured Debt rating of METRO INC. (METRO or the Company) at BBB with Stable trends after today’s announcement of a definitive combination agreement pursuant to which METRO will acquire all outstanding Class A subordinate voting shares and all outstanding Class B shares of The Jean Coutu Group Inc. (Jean Coutu) for $24.50 per share (the Acquisition). The total value of the Acquisition is $4.5 billion. The Acquisition is subject to regulatory and shareholder approvals. DBRS has also downgraded METRO’s Short-Term Issuer Rating to R-2 (middle) from R-2 (high), a level in line with the long-term ratings, reflecting the impact of the Acquisition and its corresponding financing on the Company’s previously exceptional liquidity. These actions remove the ratings from Under Review with Developing Implications.

Jean Coutu is Québec’s leading pharmacy retailer with approximately 418 franchise stores predominantly located in that province and approximately 1,350 employees (as at March 4, 2017, including Pro Doc Ltée, Jean Coutu’s generic drug manufacturing subsidiary). DBRS views Jean Coutu as having a strong brand and market position in Québec, as well as a relatively small generic drug manufacturing business, but also notes its geographic concentration and greater exposure to regulatory reforms. The Acquisition will strengthen METRO’s presence in the Québec pharmacy business and enhance its capabilities, scale and product diversification, complementing its Brunet pharmacy business. DBRS considers the pharmacy business to have favourable demographics that support better growth prospects for prescription drug, health and wellness products compared with typical food retail. Subsequent to the Acquisition, the combined pharmacy business will be a leading destination for professional services and health, beauty and wellness products in Québec with a network of more than 675 independent stores. METRO’s existing pharmacy distribution and franchising business will be combined with Jean Coutu and operate as a stand-alone division of METRO with its management team led by François Jean Coutu.

Pro forma the Acquisition, METRO’s net sales and EBITDA would be approximately $16.2 billion and approximately $1.3 billion (versus approximately $12.9 billion and $952 million for the last 12 months ended Q3 F2017), respectively. Going forward, DBRS believes METRO’s sales should increase in the low-single-digit range per year, increasing toward and above the $16.5 billion level over the medium term. EBITDA margins are expected to benefit primarily from the achievement of synergies, estimated by METRO at approximately $75 million within three years, a level considered achievable by DBRS. Synergies are expected to be driven primarily from warehouse rationalization, including use of Jean Coutu’s state-of-the-art distribution centre for the pharmacy business, procurement, reduction of duplicate operating and administrative costs, cross-selling and implementation of Jean Coutu’s retail pharmacy software. As such, DBRS expects METRO’s EBITDA subsequent to the Acquisition to continue to increase toward the $1.4 billion level over the medium term.

METRO has stated its intention to finance the cash portion of the Acquisition in a manner intended to maintain a strong and flexible balance sheet and its BBB ratings. The Company has access to committed bank facilities of $3.4 billion to finance the cash portion of the Acquisition at close but has stated that it intends to reduce the committed bank facilities through permanent financing and the sale of certain assets.

DBRS believes that benefits to the Company’s business profile because of the Acquisition should afford METRO a higher leverage level than previously considered acceptable for the BBB ratings. As such, DBRS has increased its lease-adjusted debt-to-EBITDA threshold for METRO’s current BBB rating to up to 3.0 times (x) from the previous 2.5x. DBRS notes that the lease-adjusted debt-to-EBITDAR range for BBB-range ratings (i.e., low to high) is 2.0x to 3.5x as stated in the DBRS methodology “Rating Companies in the Merchandising Industry.” While DBRS recognizes that the Acquisition (in addition to the purchase of the remaining un-owned interest in Marché Adonis) will result in a meaningful increase in METRO’s balance sheet debt and weaker credit metrics, DBRS believes that METRO’s credit metrics could return to the new acceptable levels within a reasonable time frame based on the Company’s commitment, which may include the use of free cash flow that the Company estimates at approximately $500 million per year, as well as the possible sale of its owned shares in Alimentation Couche-Tard.

The Stable trends on the ratings reflect DBRS’s view that METRO should be successful in integrating Jean Coutu and delivering acceptable operating performance while returning credit metrics to acceptable levels (i.e., lease-adjusted debt-to-EBITDAR below 3.0x within an acceptable time frame (12 to 24 months)).

The downgrade of the Company’s Short-Term Issuer Rating to R-2 (middle) from R-2 (high) reflects the change in liquidity resulting from the financing of the Acquisition. The Company’s previous R-2 (high) rating was an exception to DBRS’s methodology, which typically links a Company’s short-term and long-term ratings. Subsequent to the Acquisition, DBRS believes METRO’s liquidity will remain solid for the current BBB ratings based on the Company’s free cash flow-generating capacity and undrawn $600 million revolving credit facility.

METRO’s ratings are supported by its solid market positions in food retail in Ontario and food and pharmacy retail in Québec; its diversified product offerings, store formats and banners; good locations; and its history of disciplined financial management. The Company’s ratings also reflect intense competition in food retail in Canada, its geographic concentration in Canada’s most competitive markets, the risk of more aggressive financial management and its new exposure to generic-drug pricing reforms (balanced by near-term certainty provided by the recent announcement of an agreement in Québec).

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 principal methodology is Rating Companies in the Merchandising Industry, which can be found on dbrs.com under Methodologies.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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