DBRS Confirms Loblaw at BBB, Changes Trend to Stable after Choice Properties Acquisition of CREIT

DBRS Limited (DBRS) confirmed the ratings of Loblaw Companies Limited (Loblaw) and Shoppers Drug Mart Corporation (guaranteed by Loblaw) at BBB after the announcement that Choice Properties Real Estate Investment Trust (CP REIT; rated BBB by DBRS) has entered into an agreement to acquire the assets and assume the liabilities of Canadian Real Estate Investment Trust (CREIT; the Acquisition). The trend on the ratings has been changed to Stable from Positive.

CP REIT is expected to acquire the assets of CREIT for a total value of approximately $6 billion, forming the largest real estate investment trust (REIT) in Canada with a combined gross leasable area of approximately 69 million square feet and pro forma net operating income of approximately $889 million. The Acquisition is expected to be financed using a combination of CP REIT units, the assumption of existing CREIT indebtedness (nearly $1.5 billion of mortgage debt and $450 million unsecured debentures) and incremental debt in the form of a $1.25 billion term loan facility, as well as an $850 million bridge facility. DBRS expects the bridge facility will be repaid using proceeds from an unsecured debt issuance prior to closing. CREIT’s unsecured debentures are expected to be provided with an upstream guarantee from Choice Properties Limited Partnership (rated BBB by DBRS) making them pari passu with CP REIT’s existing unsecured debentures. The Acquisition is subject to approval by CREIT unit holders and is expected to close in the second quarter of 2018.

As a result of the issuance of CP REIT units to complete the Acquisition, Loblaw’s effective ownership in CP REIT is expected to decline to approximately 62% (or 66% when combined with the direct ownership from George Weston Ltd.) from approximately 82% (or 88% when combined with the direct ownership from George Weston Ltd.). DBRS believes that Loblaw’s business risk profile will nevertheless improve modestly as a result of the Acquisition despite the dilution in its effective ownership based on improved scale, diversification and the contractual nature of CREIT’s revenues. Prior to the Acquisition, CREIT was rated BBB, with a Stable trend, by DBRS.

The trend change to Stable from Positive reflects the increase in leverage attributable to Loblaw and CP REIT (estimated by DBRS at approximately 3.66 times (x) lease-adjusted debt-to-adjusted EBITDAR pro forma the Acquisition versus 3.04x for the last 12 months ended Q3 2017) as a result of the Acquisition and the Company’s ongoing litigation related to tax avoidance claims by the Canada Revenue Agency, combined with ongoing uncertainty surrounding the possible impacts of lawsuits, settlements and other costs related to the bread price-fixing investigation by the Competition Bureau. These factors have been considered in conjunction with headwinds faced by the retail business in 2018 from minimum wage increases and recently announced and possible additional generic-drug pricing and health-care reforms.

The Acquisition notably diversifies CP REIT’s revenue from tenants other than Loblaw, reducing Loblaw’s contribution to approximately 58% from approximately 88% prior to the Acquisition. These newly acquired real estate assets feature significant contractual revenues, and greater levels of stability have typically been afforded higher leverage levels for the same rating categories relative to merchandising companies. As such, despite the small relative size of the Acquisition (CREIT would account for approximately 8.0% of Loblaw’s consolidated EBITDA pro forma the Acquisition), DBRS believes that Loblaw should therefore be afforded higher leverage for the same rating than previously considered (i.e., lease-adjusted debt-to-adjusted EBITDAR attributable to Retail and CP REIT around 4.0x for the BBB rating versus approximately 3.75x previously).

If DBRS becomes confident that the ultimate impact of the bread-price fixing investigation and its related costs, as well as the ongoing tax litigation, will not have a material impact on Loblaw, including any effects on future profitability; that the Company’s operating performance will remain sound (in particular the Company’s ability to offset the effects of the minimum wage increase and generic drug pricing reforms in the near term and its capacity to continue to deliver same-store sales and EBITDA growth over the medium term); and credit metrics improve toward the new range considered appropriate for the BBB (high) rating category (i.e., lease-adjusted debt-to-adjusted EBITDAR below 3.50x), a positive rating action could result.

DBRS believes that Loblaw’s ratings continue to be well placed for the current BBB rating supported by its business profile, which is considered very strong for the current BBB rating, featuring industry-leading size, scale and market positions in food retail and pharmacy across Canada, as well as its significant real estate presence (bolstered by the acquisition of CREIT’s assets). The ratings also incorporate the intense competition in food retail in Canada and risks associated with drug pricing and health-care reforms.

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

The principal methodologies are Rating Companies in the Merchandising Industry, Rating Entities in the Real Estate Industry, DBRS Criteria: Guarantees and Other Forms of Support and DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers, which can be found on dbrs.com under Methodologies.

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 under Related Documents or by contacting us at info@dbrs.com.

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

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