DBRS Confirms Sobeys Inc. at BB (high), Stable, Following Acquisition of Farm Boy

DBRS Limited (DBRS) confirmed the Issuer Rating and Senior Unsecured Debt rating of Sobeys Inc. (Sobeys or the Company) at BB (high) with Stable trends. The Recovery Rating on the Company’s Senior Unsecured Debt was also confirmed at RR3. The rating actions follow Sobeys’ announcement that it has agreed to acquire Farm Boy for $800 million (the Acquisition), financed through a combination of cash on hand and a new $400 million bank facility. The Acquisition is subject to customary closing conditions, including a review by the Canadian Competition Bureau, and is expected to close at the beginning of 2019.

Farm Boy is an Ontario-based retail grocer with 26 stores predominantly located in the Ottawa region. Farm Boy offers a broad range of premium-quality private-label products in multiple categories as well as prepared foods with a focus on locally sourced meat and produce. Farm Boy has grown rapidly to approximately $500 million in sales by doubling its store count over the last five years and delivering a three-year average same-store sales growth rate of 5.3%. Sobeys estimates that Farm Boy will generate more than $55 million in EBITDA in F2020. Farm Boy will be set up as a subsidiary of the Company and will continue to be run by its current Co-Chief Executive Officers.

On March 15, 2018, DBRS changed the trend on Sobeys’ Issuer Rating and Senior Unsecured Debt rating to Stable from Negative and confirmed both ratings at BB (high) following the Company’s Q3 F2018 results. DBRS also confirmed the Recovery Rating of RR3 on Sobeys’ Senior Unsecured Debt. At that time, DBRS stated that, if the Company successfully maintained either positive same-store sales or those in line with its peers and increased operating income toward a run rate of approximately $1.0 billion per year, the trend would likely change to Positive from Stable.

Since then, Sobeys has reported two quarters of results. In Q4 F2018, same-stores sales were flat and adjusted-EBITDA margins improved 50 basis points because of operating leverage and benefits from Project Sunrise. As a result, adjusted EBITDA improved approximately 17.4% year over year to $207 million. In Q1 F2019, same-store sales increased 1.3%. Despite pressure from higher transportation and labour costs, health-care reform and the closure of ten underperforming stores in Western Canada, adjusted EBITDA only declined to $246 million in Q1 F2019 from $264 million in Q1 F2018. The Company was able to comfortably generate positive free cash flow after dividends and repaid $100 million of debt in this period. Sobeys is now tracking close to a $1.0 billion run rate of EBITDA which, when combined with current credit metrics for the last 12 months ended Q1 F2019 (lease-adjusted debt-to-EBITDAR at 3.39 times (x) and lease-adjusted EBITDAR coverage at 5.32x), is consistent with an investment-grade credit profile.

Sobeys’ recent results support a change in trend to Positive from Stable; however, because of the pro-forma increase in leverage associated with the Acquisition (lease-adjusted debt-to-EBITDAR increasing toward 3.60x and lease-adjusted EBITDAR coverage declining to approximately 5.20x), DBRS will maintain the Stable trend for another two quarters of stable operating performance. Should Sobeys continue to maintain either positive same-store sales or those in line with its peers, increase operating income toward a run rate of approximately $1.0 billion per year and/or apply some free cash flow toward debt repayment, the trend could be revised to Positive.

Going forward, DBRS expects the Company to accelerate Farm Boy’s growth in Ontario by investing in new store locations and converting underperforming Sobeys stores into Farm Boy locations. The Company plans to double Farm Boy’s store count within five years. Although DBRS understands the merits of the Acquisition, including a stronger market position in Ontario and the benefit of Farm Boys’ strong private-label brands, the Acquisition does not have a material effect on Sobeys’ business risk assessment because of its small size.

Sobeys’ 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 its 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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