DBRS Morningstar Upgrades METRO INC.’s Issuer Rating and Senior Unsecured Debt Rating to BBB (high) from BBB, Changes Trends to Stable

DBRS Limited (DBRS Morningstar) upgraded METRO INC.’s (Metro or the Company) Issuer Rating and Senior Unsecured Debt rating to BBB (high) from BBB and changed the trends on both credit ratings to Stable from Positive. The credit rating upgrades reflect the gradual strengthening of Metro’s business risk profile since before the successfully integrated acquisition of Jean Coutu, which closed in 2018. This is evidenced by the Company’s long-term track record of consistent same-store sales growth and EBITDA margin expansion. Moreover, the upgrades also reflect the long-term improvement in Metro’s key credit metrics, to a level supportive of a BBB (high) credit rating, through earnings growth. Lastly, the actions reflect DBRS Morningstar’s expectation that the Company will be able to sustain key credit metrics at this level.

On December 15, 2022, DBRS Morningstar changed the trends on Metro’s credit ratings to Positive from Stable. At that time, DBRS Morningstar stated that, should Metro continue to deliver operating performance generally in line with DBRS Morningstar’s expectations while maintaining relatively stable credit metrics, DBRS Morningstar would likely upgrade the credit ratings to BBB (high) over the course of the next year.

Since then, Metro reported results for the nine months ended July 1, 2023 (9M F2023). The Company’s earnings profile continued to show strength against the backdrop of a challenging operating environment, marked by decreasing consumer purchasing power. Sales increased by 8.3% to $15.7 billion during 9M F2023 from $14.5 billion during the same period last year. This was primarily driven by strong high-single-digit food and pharmacy same-store sales growth, growth in e-commerce, and new store openings. EBITDA margins modestly expanded, as a slight decline in gross margins (largely due to continued input cost inflation) was more than offset by decreased selling, general, and administrative expenses as a percentage of sales, benefitting from operating leverage gains. As such, EBITDA increased to $1.5 billion during 9M F2023 from $1.4 billion during the same period last year.

Furthermore, Metro continued to generate a meaningful level of free cash flow (FCF; after dividends but before changes in working capital and principal operating lease payments), growing to $515 million in the 9M F2023 from $441 million in the 9M F2022. The Company primarily used its FCF, after $149 million of net principal operating lease payments, in combination with $276 million of net debt issuances, for $508 million in net share buybacks. As a result, key credit metrics continued to modestly strengthen for the last 12 months ended July 1, 2023, with debt-to-EBITDA, EBITDA interest coverage, and cash flow-to-debt improving to 2.2 times (x), 14.7x, and 35.8%, respectively, from 2.3x, 13.7x, and 34.9%, respectively, in F2022.

Looking ahead, DBRS Morningstar believes that Metro’s operating performance could be pressured from near-term headwinds related to decreased consumer purchasing power. That said, given the relatively inelastic nature of the Company’s product offering combined with its solid footprint of discount banners and private label offerings, DBRS Morningstar believes Metro is well positioned to navigate this challenging period. DBRS Morningstar expects the now-resolved roughly one-month-long labour dispute at 27 stores in the Greater Toronto Area to have a relatively minor impact on Metro’s full-year operating results. Over the more medium term, DBRS Morningstar expects the Company’s earnings profile to continue to strengthen, supported by sound same-store sales growth and a gradual EBITDA margin expansion. DBRS Morningstar forecasts sales to grow to approximately $20.5 billion in F2023, benefitting from continued sound food and pharmacy same-store sales growth as well as a 53rd week, and toward $21.0 billion in F2024. DBRS Morningstar expects Metro to try to pass on some of the input costs and wage increases through pricing and benefit from operating leverage gains as well as an increase in higher-margin private label and pharmacy sales, resulting in EBITDA margins remaining relatively stable in F2023 and F2024. DBRS Morningstar notes that, while the opening of Metro’s new automated distribution center north of Montréal should yield operational efficiencies, transition and start-up costs are likely to put some pressure on near-term operating performance. As such, DBRS Morningstar believes Metro's EBITDA will grow to approximately $2.0 billion in F2023 and to above $2.0 billion in F2024.

DBRS Morningstar expects Metro’s financial profile to remain relatively stable going forward. This is based on DBRS Morningstar’s view that, despite elevated capital expenditure (capex) levels over the near term and continued share buybacks, which will likely require some incremental debt, the Company’s credit metrics will remain relatively stable, supported by earnings growth. DBRS Morningstar forecasts cash flow from operations (as calculated by DBRS Morningstar) to track operating income and to be approximately $1.5 billion in F2023 and F2024. Capex is projected to remain elevated, increasing to approximately $800 million in F2024, with capex primarily related to the Company’s efforts to modernize its supply chain, before decreasing thereafter to a more normalized level in the $500 million range. Cash outlay for dividends is expected to grow toward $300 million over the next two years. As such, DBRS Morningstar believes FCF after dividends but before changes in working capital and net principal operating lease payments will remain above $400 million in F2023 and F2024. After changes in working capital and net principal operating lease payments, DBRS Morningstar anticipates the Company will primarily use its FCF and likely some incremental debt for share buybacks such that credit metrics remain appropriate for the new BBB (high) credit rating category (i.e., debt-to-EBITDA below 2.5x on a normalized and sustained basis).

Although highly unlikely over the medium term, DBRS Morningstar could take a positive credit rating action should Metro’s business risk profile materially strengthen, coupled with a commensurate improvement in credit metrics on a normalized and sustainable basis. Conversely, should credit metrics deteriorate (i.e., debt-to-EBITDA rises to above 2.5x on a sustained basis, along with a similar decline in the Company’s other key credit metrics), as a result of either weaker-than-expected operating performance and/or more aggressive financial management, DBRS Morningstar could take a negative credit rating action.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/416784 (July 4, 2023).

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

DBRS Morningstar applied the following principal methodology:
-- Global Methodology for Rating Companies in the Merchandising Industry (July 21, 2023; https://www.dbrsmorningstar.com/research/417461)

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.

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 [email protected].

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar trends and credit ratings are under regular surveillance.

Information regarding DBRS Morningstar credit ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at [email protected].

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