DBRS Changes Trend on Sobeys Inc. to Positive

DBRS Limited (DBRS) changed the trends on the Issuer Rating and Senior Unsecured Debt rating of Sobeys Inc. (Sobeys or the Company) to Positive from Stable 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 the continuation of the Company’s recovering market share and operating performance since DBRS’s confirmation of the ratings at BB (high) with Stable trends on September 25, 2018, following its $800 million acquisition of Farm Boy.

At that time, DBRS stated that despite Sobeys’ recent results supporting a change in trend to Positive from Stable, DBRS would maintain the Stable trend for another two quarters of stable operating performance because of the pro forma increase in leverage associated with the Farm Boy acquisition. DBRS also specified that should Sobeys continue to maintain either positive same-store sales or sales 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.

Since then, Sobeys has reported two quarters of results, and its earnings profile has continued to recover from two years ago, when the ratings were downgraded to BB (high) with a Negative trend. The Company has reported same-stores sales (excluding fuel) of 2.5% and 3.3% in Q2 and Q3 F2019, respectively. The same-store sales reflected strong tonnage growth that surpassed its peers over this period, and EBITDA margins strengthened based on stable gross margin, cost savings related to Project Sunrise and operating leverage, despite increases in minimum wage rates and higher transportation costs. As a result, EBITDA was $260 million and $178 million in Q2 and Q3 F2019, respectively. DBRS notes that Q3 F2019 EBITDA included $45 million of costs related to British Columbia labour buyouts and FreshCo conversions.

For the last 12 months ended February 2, 2019, lease-adjusted debt-to-EBITDAR and lease-adjusted EBITDAR coverage was 3.67 times (x) and 5.47x, respectively. DBRS believes these credit metrics are consistent with an investment-grade credit profile, particularly since they have benefitted from a recovering EBITDA to an annual run rate of approximately $1.0 billion.

Going forward, DBRS expects Sobeys’ revenue to increase modestly to more than $25 billion in F2020 based on same-store sales in the low single-digits and the contribution from Farm Boy. 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 through F2020, as cost savings from Project Sunrise and operating leverage are partially offset by FreshCo conversion costs. As a result, DBRS expects EBITDA to be around $1 billion in F2020.

DBRS expects cash flow from operations to track the growth in operating income, increasing above $700 million in F2020. DBRS forecasts capital expenditures to increase to over $500 million in F2020 as the Company converts Safeway and Sobeys stores in Western Canada to FreshCo stores and continues 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, DBRS anticipates that Sobeys will generate positive free cash flow after dividends and before changes in working capital in F2020, which could be available for debt repayment. DBRS notes that an upgrade to BBB (low) is not reliant on debt reduction going forward.

In the next two to four quarters, should Sobeys continue to maintain either positive same-store sales or sales in line with its peers and continue to maintain operating income near a run rate of approximately $1.0 billion per year, the ratings could be upgraded to BBB (low). The Company’s credit metrics are currently consistent with an investment-grade rating, and DBRS will assess the Company’s near-term performance to ensure the recovery is sustainable before an upgrade ensues.

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 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 & Criteria.

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.

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