DBRS Changes Trends on Sobeys Inc.’s Ratings to Stable from Negative

DBRS Limited (DBRS) changed the trends on the Issuer Rating and Senior Unsecured Debt rating of Sobeys Inc. (Sobeys or the Company) to Stable from Negative and confirmed both ratings at BB (high). The Recovery Rating on the Company’s Senior Unsecured Debt was also confirmed at RR3. The rating actions reflect Sobeys’s stabilized market share and recovering operating performance over the last 12 months (LTM) ended February 3, 2018.

On March 15, 2017, following Sobeys’s Q3 F2017 results, DBRS downgraded the Issuer Rating and Senior Unsecured Debt rating to BB (high) from BBB (low) and maintained the Negative trends. DBRS also assigned a Recovery Rating of RR3 to the Company’s Senior Unsecured Debt. At that time, DBRS stated that if over the next four quarters Sobeys successfully narrowed and/or reversed the gap in same-store sales relative to peers and/or reversed the downward trajectory in operating income above a run rate of approximately $600 million annually, the trends could be returned to Stable.

Since then, Sobeys has performed progressively better relative to its peers and operating income has improved materially. Revenue increased to $24.1 billion, 1.3% higher than F2017 revenues. The increase was mainly because of same-store sales growth, which, excluding fuel, was -1.6%, 0.5%, 0.4% and 1.1% over the last four quarters, respectively. The increase in same-store sales was primarily driven by food inflation as volumes were relatively stable. The Company was able to achieve revenue growth without sacrificing gross margin. EBITDA margin also benefited from cost reductions associated with Project Sunrise. As such, adjusted EBITDA for the LTM ended February 3, 2018, increased to $869 million, up by 25.6% from F2017. The increase in earnings helped the Company comfortably generate positive free cash flow after dividends. As a result of the increase in operating income and $100 million of debt repayment subsequent to Q3 F2017, the Company’s pro forma lease-adjusted debt-to-EBITDAR and lease-adjusted EBITDAR coverage improved to 3.37 times (x) and 5.17x, respectively, from 3.99x and 4.48x, respectively, as at the end of F2017.

Going forward, DBRS expects Sobeys’s revenue to increase modestly to more than $24.3 billion in F2019 based on same-store sales in the 1% range (mainly the result of inflation). Sobeys continues to expect Project Sunrise to deliver at least $500 million in annualized cost savings by F2020. DBRS forecasts EBITDA margins to improve moderately in F2019 as cost savings from Project Sunrise and operating leverage are partially offset by minimum wage increases (up to $90 million in F2019, including the wage parity impact of the Fair Workplaces, Better Jobs Act, 2017) and the impact of health-care reform (up to $40 million in F2019). As a result, DBRS expects EBITDA to be around $900 million in F2019.

DBRS expects cash flow from operations to track the growth in operating income, increasing above $650 million in F2019. DBRS forecasts capital expenditures to increase in F2019 as the Company begins converting some Safeway and Sobeys stores in Western Canada to FreshCo stores and begins the construction of its first Customer Fulfillment Centre as part of its agreement with Ocado Group plc to roll out its grocery delivery platform. DBRS expects the Company’s dividend payout to remain stable. As a result of the above factors, DBRS anticipates that Sobeys will generate positive free cash flow after dividends and before changes in working capital in F2019, which could be available for debt repayment. However, DBRS expects credit metrics to continue improving because of growth in earnings.

Over the near to medium term, if Sobeys is successful in maintaining either positive same-store sales, or those in line with its peers, and increasing operating income towards a run rate of approximately $1.0 billion per year, the trends would likely be changed to Positive from Stable. Although leverage and coverage metrics are currently consistent with an investment-grade rating, DBRS will assess the Company’s performance over the next two to four quarters to ensure the recovery is sustainable before a positive rating action ensues. While the Company could use capital-conserving and other measures to improve credit metrics through debt reduction, further positive rating actions will continue to be more influenced by operating performance.

Sobeys’s ratings continue to be supported by its number-two position in the Canadian food retailing market and its diversification across the country, balanced by intense competition and execution risks associated with the Company’s continued turnaround strategy.

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

The principal methodologies are Rating Companies in the Merchandising Industry and DBRS Criteria: Recovery Ratings for Non-Investment Grade 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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