DBRS Upgrades Ratings on Sobeys Inc. to BBB (low), Changes Trend to Stable

DBRS Limited (DBRS) upgraded the Issuer Rating and Senior Unsecured Debt rating of Sobeys Inc. (Sobeys or the Company) to BBB (low) from BB (high). DBRS also changed the trends to Stable from Positive. As the rating on the Senior Unsecured Debt is now investment grade, the recovery rating is no longer applicable. The rating actions reflect the Company’s very strong operating performance in Q4 F2019, well above DBRS’s forecast, and the expectation that this recovery is sustainable going forward.

Following the Company’s Q3 F2019 results, DBRS confirmed its ratings at BB (high) and changed the trends to Positive from Stable on March 19, 2019. At that time, DBRS stated that if Sobeys continued to maintain either positive same-store sales or sales in line with its peers and continued to maintain operating income near a run rate of approximately $1.0 billion per year in the following two to four quarters, DBRS would consider upgrading the ratings to BBB (low). DBRS also noted that Sobeys’ credit metrics were already consistent with an investment-grade rating and that DBRS would assess the Company’s near-term performance to ensure that the recovery was sustainable before an upgrade ensued.

While only Q4 F2019 results have been reported since that time, they were well ahead of DBRS’s expectation. The Company’s earnings profile has continued to recover from two years ago, when the ratings were downgraded to BB (high) with a Negative trend. DBRS’s confidence in the sustainability of the recovery has increased as Sobeys reported same-stores sales (excluding fuel) of 3.8%, well above its peers, driven by tonnage growth and inflation. EBITDA margin improved by more than 50 basis points because of category resets and cost cutting associated with Project Sunrise as well as operating leverage, despite increases in minimum wage rates and the inclusion of Farm Boy Inc. (Farm Boy) results. As a result, adjusted EBITDA was $270 million in Q4 F2019, up from $225 million in Q4 F2018.

For the last 12 months ended May 4, 2019, lease-adjusted debt-to-EBITDAR and lease-adjusted EBITDAR coverage were 3.60 times (x) and 5.50x, respectively. DBRS believes that these credit metrics remain consistent with an investment-grade credit profile, particularly since they have benefited from a recovering EBITDA.

Going forward, DBRS expects Sobeys’ revenue to increase toward $26 billion in F2020 based on same-store sales in the 2% range and Farm Boy’s contribution. DBRS believes that EBITDA margins will continue to grow because of continued benefits from Project Sunrise (approximately $300 million to date), including further category resets, and operating leverage. Sobeys now expects Project Sunrise to deliver at least $550 million in annualized cost savings by F2020, up from its previous guidance of $500 million. As a result, DBRS forecasts EBITDA to be more than $1.1 billion in F2020.

DBRS expects cash flow from operations to track growth in operating income, increasing above $900 million in F2020. DBRS forecasts capex to be approximately $600 million in F2020 as the Company converts 13 Safeway and Sobeys stores in Western Canada to FreshCo stores, invests in Farm Boy 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. The Company’s dividend payout remains modest following the announced 9% increase. As a result, DBRS anticipates that Sobeys will generate positive free cash flow (FCF) after dividends and before changes in working capital in F2020, which can comfortably fund its $100 million share repurchase program.

DBRS does not expect a material amount of debt reduction but, based on growth in operating income, believes that credit metrics will improve (i.e., lease-adjusted debt-to-EBITDAR below 3.5x and lease-adjusted interest coverage approaching 6.0x). Over the near to medium term, if lease-adjusted debt-to-EBITDAR continues to improve toward 3.0x as a result of continued growth in operating income or the application of FCF toward debt reduction, DBRS could change the trend to Positive.

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 the intensely competitive environment.

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

The principal methodology is Rating Companies in the Merchandising Industry, 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.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.

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