DBRS Confirms Loblaw at BBB, Stable, after Announcement of the Spin-Out of Its Interest in Choice Properties

DBRS Limited (DBRS) confirmed the Issuer Rating, Medium-Term Notes rating and Debentures rating of Loblaw Companies Limited (Loblaw or the Company) at BBB, as well as the Company’s Short-Term Issuer Rating at R-2 (middle) and Second Preferred Shares rating at Pfd-3. All trends are Stable. DBRS also discontinued the BBB rating on Shoppers Drug Mart Corporation’s Senior Unsecured Debt, which was repaid in Q2 2018.

The confirmation of the ratings follows the Company’s announcement of a reorganization under which Loblaw will spin out its 61.6% interest in Choice Properties Real Estate Investment Trust (CPREIT or Choice Properties; rated BBB with a Stable trend by DBRS; the Transaction). Loblaw shareholders other than its parent, George Weston Limited (GWL; rated BBB with a Stable trend by DBRS), will receive 0.135 of a GWL common share per Loblaw share, which is equivalent to the market value of the Loblaw shareholders pro rata interest in CPREIT. GWL will receive Loblaw’s 61.6% interest in Choice Properties. Loblaw will not retain any equity interest in Choice Properties. The arrangement will require the approval of at least 66 2/3% of Loblaw common shareholders and a majority of Loblaw minority shareholders. The votes are expected to take place in October 2018, and while the Transaction is also subject to customary closing conditions, the Company expects the Transaction to close in Q4 2018.

The rating action reflects the continued application of the DBRS methodology “Rating Companies in the Merchandising Industry” (the Methodology). DBRS believes the business risk factor for real estate as outlined in the Methodology will be weaker because the Company owns less real estate (directly and indirectly) and would concurrently reduce the key credit metric of lease-adjusted debt-to-EBITDAR considered acceptable for the BBB rating category by 0.5 times (x). In addition, DBRS will no longer include the earnings and balance sheet debt of Choice Properties when assessing Loblaw’s key credit metrics. DBRS will, however, include the rent paid to Choice Properties, approximately $516 million in 2017, along with the other third-party rent when capitalizing operating leases at 6.0x to calculate key credit metrics. The decline in acceptable leverage for the current rating category consists of adjustments to offset the previous increase made after Choice Properties acquired Canadian Real Estate Investment Trust and because the Company no longer indirectly owns Choice Properties’ underlying real estate assets.

Loblaw’s ratings will continue to be supported by its industry-leading size and scale, geographic and banner diversification, strength of its private-label and loyalty programs and control of its real estate through the GWL group of companies. The ratings also reflect intense retail competition, ongoing health-care reforms and the high rate of union penetration. DBRS believes that the strength of Loblaw’s business profile should afford it higher leverage than typical for a particular rating category. As a result, DBRS believes that the lease-adjusted debt-to-EBITDAR attributed to the retail business of up to 3.5x would be appropriate for the BBB rating category. Pro forma the Transaction, DBRS forecasts Loblaw’s lease-adjusted debt-to-EBITDAR attributed to retail will be approximately 3.1x in 2018.

After the Transaction, DBRS expects Loblaw’s free cash flow to be in the $1.0 billion per-year range, which is considered strong as a percentage of balance sheet debt attributed to retail (approximately $6.0 billion as of Q2 2018). DBRS believes that free cash flow will continue to be used to invest in growth and/or increase shareholder returns rather than to repay debt. Should Loblaw’s key credit metrics improve modestly (i.e., lease-adjusted debt-to-EBITDAR attributed to retail below 3.0x) and the Company continue to overcome ongoing headwinds (i.e., rising costs (such as minimum wage), tariffs and transportation increases, drug-pricing reforms, impact of the bread-price fixing and other litigation) and grow EBITDA in the near term, a positive rating action will likely result.

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

Shoppers Drug Mart Corporation’s Senior Unsecured Debt is guaranteed by Loblaw Companies Limited.

The principal methodologies are Rating Companies in the Merchandising 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.

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