Morningstar DBRS Confirms Canadian Tire Corporation, Limited at BBB with Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating and the credit rating on the Medium-Term Notes (the Notes) of Canadian Tire Corporation, Limited (CTC or the Company) at BBB, both with Stable trends.

KEY CREDIT RATING CONSIDERATIONS
CTC’s operating performance for the year ended December 30, 2023 fell considerably below Morningstar DBRS’ expectations. Combined with $200 million incremental debt following the Company’s September 2023 Notes issuance and a further $895 million debt associated with CTC’s reacquisition of The Bank of Nova Scotia’s (rated AA with Stable trends) 20% stake in CTFS Holdings Limited (CTFS; the Reacquisition), key credit metrics deteriorated materially outside the thresholds considered appropriate for the current credit rating category (i.e., debt-to-EBITDA attributable to the Retail segment and CT Real Estate Investment Trust (CT REIT; rated BBB with a Stable trend) of not more than 3.0 times (x)). That said, Morningstar DBRS confirmed CTC’s credit ratings with Stable trends based on the expectation that, through modest earnings recovery and balanced financial management, debt-to-EBITDA attributable to the Retail segment and CT REIT should return to less than 3.0x in 2025.

On October 31, 2023, Morningstar DBRS confirmed CTC’s credit ratings with Stable trends following the Reacquisition. At that time, Morningstar DBRS projected consolidated EBITDA to decline to approximately $2.2 billion in 2023 from $2.7 billion in 2022. Similarly, Morningstar DBRS expected EBITDA attributable to the Retail segment and CT REIT to moderate to between $1.8 billion and $1.9 billion in 2023 from $2.1 billion in 2022. After accounting for the increased indebtedness associated with the Notes issuance and Reacquisition, Morningstar DBRS forecast debt-to-EBITDA attributable to the Retail segment and CT REIT to increase to around 3.2x at the end of 2023, and return to less than 3.0x by the end of 2024 on the back of a projected earnings recovery combined with balanced financial management.

The negative effect of slowing consumer demand in the fourth quarter of 2023, CTC’s seasonally most important quarter of the year, was more pronounced than Morningstar DBRS expected. Additionally, unseasonable weather exacerbated the softness in the Company’s operating performance. Consequently, consolidated EBITDA declined to approximately $2.1 billion for the full-year 2023, of which $1.6 billion was attributable to the Retail segment and CT REIT. Combined with the increased indebtedness, debt-to-EBITDA attributable to the Retail segment and CT REIT deteriorated to 3.6x, materially higher than the 3.0x threshold considered appropriate for the current BBB credit rating category. Weak consumer spending and unseasonal weather persisted in the first quarter ended March 30, 2024 (Q1 2024), and more than offset the benefits of a favourable product mix and lower freight costs to consolidated EBITDA and EBITDA attributable to the Retail segment and CT REIT. Consequently, debt-to-EBITDA attributable to the Retail segment and CT REIT deteriorated further to 3.8x in the last 12 months ended Q1 2024.

CREDIT RATING DRIVERS
If Morningstar DBRS became increasingly concerned that debt-to-EBITDA attributable to the Retail segment and CT REIT were to remain more than 3.0x in 2025 because of weaker-than-expected operating performance and/or more aggressive financial management, the credit ratings could be pressured. Furthermore, Morningstar DBRS notes that weaker-than-expected operating performance for a sustained period resulting in a more permanent shift of the Company’s business risk profile could also result in the requirement to maintain stronger key credit metrics to support the same credit rating.

Conversely, Morningstar DBRS could take a positive credit rating action should the Company’s business risk profile meaningfully strengthen, and/or credit metrics attributable to the Retail segment and CT REIT materially improve on a normalized and sustainable basis.

EARNINGS OUTLOOK
Morningstar DBRS believes that persistent weakness in CTC’s discretionary banners/product categories, will continue to outweigh the benefit from higher sales volumes of essential products, thus resulting in flat to negative low single-digit comparable sales in 2024. Consequently, Morningstar DBRS forecasts consolidated revenue to decline to approximately $16.6 billion in 2024 from approximately $16.7 billion in 2023. While persistent weakness in demand for CTC’s higher-margin discretionary product offering, coupled with higher operating costs associated with the Company’s strategic growth initiatives, could continue to pressure Retail and consolidated EBITDA margins, Morningstar DBRS anticipates that this should be more than offset by moderating supply chain costs, promotional efficiencies, and cost-saving initiatives. That said, Morningstar DBRS projects that higher credit loss allowances in the CTFS segment could erode consolidated EBITDA margins to less than 2023 levels. Consequently, Morningstar DBRS forecasts consolidated EBITDA to decline to approximately $2.0 billion in 2024, of which approximately $1.6 billion is attributable to the Retail segment and CT REIT, from $2.1 billion and $1.6 billion in 2023, respectively. Looking ahead to 2025, Morningstar DBRS forecasts at least some recovery in both consolidated EBITDA and EBITDA attributable to the Retail segment and CT REIT; although considerable uncertainty about the macroeconomic outlook remains.

FINANCIAL OUTLOOK
In 2024, Morningstar DBRS forecasts free cash flow (after dividends but before changes in working capital and principal lease payments) of less than $500 million as (1) operating cash flow continues to trend in line with earnings, (2) capital expenditure increases to more than $650 million, and (3) the Company maintains its dividend policy. Morningstar DBRS expects CTC to take a balanced approach to its financial management practices such that debt-to-EBITDA attributable to the Retail segment and CT REIT improves toward 3.0x in 2024. Combined with at least some recovery in EBITDA in 2025, debt-to-EBITDA attributable to the Retail segment and CT REIT should improve to less than 3.0x in that year.

CREDIT RATING RATIONALE
CTC's credit ratings continue to reflect its strong brands and leading market position, geographic diversification, and real estate ownership and control through CT REIT. The credit ratings also reflect the intense competition, risks related to the Company's ambitions for growth, and its cyclical financial services business.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
There were no Environmental factor(s) that had a relevant or significant effect on the credit analysis.

Social (S) Factors
There were no Social factor(s) that had a relevant or significant effect on the credit analysis.

Governance (G) Factors
There were no Governance factor(s) that had a relevant or significant 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), https://dbrs.morningstar.com/research/427030.

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

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

(C) Weighting of the BRA and the FRA
In the analysis of CTC, 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

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

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