Morningstar DBRS Confirms Sobeys Inc. at BBB, With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed Sobeys Inc.'s (Sobeys or the Company) Issuer Rating and Senior Unsecured Debt credit rating at BBB with Stable trends.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations and Stable trends acknowledge Sobeys' sound operating performance over the last 12 months ended February 3, 2024 against the backdrop of a challenging operating environment considering stressed consumer purchasing power. The credit rating actions also reflect Morningstar DBRS' view that Sobeys will continue to comfortably navigate this environment within the context of the BBB credit rating category, given the Company's relatively inelastic product offering.

CREDIT RATING DRIVERS
Morningstar DBRS could take a positive credit rating action should Sobeys' business risk profile materially strengthen and key credit metrics improve commensurately as a result of growth in earnings (i.e., debt-to-EBITDA of less than 2.5 times (x) on a normalized and sustainable basis). Conversely, should Sobeys' key credit metrics deteriorate for a sustained period (i.e., debt-to-EBITDA increases to materially above 3.5x) as a result of weaker-than-expected operating performance and/or more aggressive financial management, the credit ratings could be pressured.

EARNINGS OUTLOOK
Morningstar DBRS forecasts Sobeys' revenues to be approximately $30.7 billion for the full year ended in May 2024 (F2024) and to grow to approximately $31.5 billion in F2025, from $30.5 billion in F2023, primarily driven by low to mid-single digit same-store sales growth. This is based on Morningstar DBRS' expectation of moderating inflationary pressures on prices and the effects of strained consumer purchasing power on volumes, especially considering Sobeys' relatively lower level of discount banner penetration, while also acknowledging benefits associated with Canada's considerable population growth. Sobeys' revenue growth should also see some benefit from the Company's growth initiatives, including new stores, renovations and conversions, as well as e-commerce. Morningstar DBRS notes that F2024 revenue growth is negatively affected by the Company's sale of close to 60 retail fuel sites in Western Canada, which closed in Q1 F2024. Morningstar DBRS forecasts Sobeys' EBITDA margins to expand modestly, with operating leverage gains and cost reduction efforts expected to offset the negative effects associated with the Company's e-commerce roll-out, store remodelling and conversion efforts, as well as general cost pressures, including on wages. As such, Morningstar DBRS forecasts EBITDA to be approximately $2.2 billion for the full year F2024 and $2.3 billion in F2025, versus $2.1 billion in F2023.

FINANCIAL OUTLOOK
Morningstar DBRS expects Sobeys' financial profile to remain appropriate for the current credit ratings as key credit metrics are forecast to gradually strengthen with growth in earnings. Morningstar DBRS forecasts operating cash flows to continue to generally trend in line with earnings and be approximately $1.8 billion in both F2024 and F2025 versus approximately $1.6 billion in F2023. Capital expenditures are anticipated to be elevated in F2024 at close to $900 million, largely because of a land acquisition for future development, but should moderate into the $700 million range (similar to recent years) in F2025. Annualized dividend payments to Empire Company Limited are expected to continue to gradually increase and average approximately $600 million in F2024 and F2025. Morningstar DBRS forecasts Sobeys will use its remaining free cash flows primarily for lease principal payments. As such, key credit metrics should remain appropriate for the Company's current credit ratings (i.e., debt-to-EBITDA below 3.5x).

CREDIT RATING RATIONALE
Sobeys' credit 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.

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

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of Sobeys, the relative weighting of the BRA factors was approximately equal.

(B) Weighting of FRA Factors
In the analysis of Sobeys, the relative weighting of the FRA factors was approximately equal.

(C) Weighting of the BRA and the FRA
In the analysis of Sobeys, the BRA carries greater weight than the FRA.

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Companies in the Merchandising Industry (April 15, 2024),
https://dbrs.morningstar.com/research/431175

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186, which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodologies have also been applied:
-- Morningstar DBRS Global Corporate Criteria (15 April 2024) https://dbrs.morningstar.com/research/431186
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030

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

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

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@morningstar.com.

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.

Morningstar DBRS 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. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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