Morningstar DBRS Assigns an Issuer Rating of BB and Provisional Senior Unsecured Notes Rating of (P) BB (low) to Sleep Country Canada Holdings Inc., Stable Trends

DBRS Limited (Morningstar DBRS) assigned a final Issuer Rating of BB and a provisional Senior Unsecured Notes rating of (P) BB (low) to Sleep Country Canada Holdings Inc. (Sleep Country or the Company), both with Stable trends. The Senior Unsecured Notes rating is based on a recovery rating of RR5.

KEY CREDIT RATING CONSIDERATIONS
The credit ratings are supported by Sleep Country's strong market position within the Canadian sleep specialty retail industry, solid retail brand strength and brand portfolio, and strong free cash flow generating capacity. The credit ratings also take into consideration the intense competitive environment within the industry, the Company's exposure to economic cycles, and risks associated with acquisitions.

The provisional credit rating on the proposed $300 million Senior Unsecured Notes (the Notes) is not a final credit rating with respect to the above-mentioned security and may change or be different from the final credit rating assigned or may be discontinued. The provisional credit rating on the Notes is based on annual reports; quarterly financial statements; management budgets; a draft Description of Notes for the proposed Senior Unsecured Notes; and information provided by Sleep Country to Morningstar DBRS as of November 20, 2024. The assignment of a final credit rating on the Notes is subject to receipt by Morningstar DBRS of all information and final documentation that Morningstar DBRS deems necessary to finalize the credit rating.

The Company is expected to use the proceeds from the proposed Notes to repay outstanding senior secured indebtedness. The Notes are expected to be subordinated to the Company's Senior Secured Credit Facilities and structurally subordinated to any debt or other liabilities of any non-guarantor subsidiaries. The Notes will be guaranteed by all the Company's subsidiaries at the time of issuance.

CREDIT RATING DRIVERS
Should Sleep Country materially improve its business-risk profile, including increased size and scale, while deleveraging in line with Morningstar DBRS expectations, a positive credit rating action could occur. Furthermore, should the Company maintain earnings at current levels and repay its senior secured obligations, such that the recovery position of the Notes materially improves, a positive credit rating action on the Notes could occur. Conversely, should Sleep Country's credit metrics remain elevated for a sustained period, and/or should the Company experience a material and sustained deterioration in operating income and/or the recovery on the Senior Unsecured Notes deteriorates, a negative credit rating action could ensue.

EARNINGS OUTLOOK
Looking ahead, Morningstar DBRS anticipates Sleep Country's earnings profile will remain appropriate for the current credit ratings and experience modest earnings growth in 2024 and 2025. Morningstar DBRS forecasts Sleep Country's revenue will grow in the low-single digits to over $950 million in 2024 and toward $1 billion in 2025. Revenue growth is expected to be primarily driven by a full year of contribution from the 2023 acquisitions of Silk and Snow and the Canadian operations of Casper Sleep, new store growth, and pricing actions partially attributable to product premiumization. Morningstar DBRS expects revenue growth to be partially offset by low-single digit same store sales declines in 2024, before experiencing some recovery in the latter half of 2025. In terms of margins, Morningstar DBRS forecasts EBITDA margins to improve modestly year-over-year in both 2024 and 2025 driven by a number of factors including the centralization and internalization of certain functions including inventory storage, improving margins in newly launched or acquired direct-to-consumer brands, continued price increases, as well as some shift in product mix toward higher margin accessories. As a result, Morningstar DBRS anticipates Sleep Country's EBITDA (as calculated by Morningstar DBRS), to improve to approximately $200 million in 2024, and toward $210 million in 2025.

FINANCIAL OUTLOOK
Morningstar DBRS expects Sleep Country's financial profile to strengthen over the near-to-medium term, driven by steady deleveraging through debt repayments and modest earnings growth. Morningstar DBRS forecasts cash flow from operations to remain relatively flat at approximately $140 million in 2024 and 2025. DBRS Morningstar expects capital expenditures to be in the $50 million to $55 million range annually over the forecast horizon, with the majority of spending allocated toward store renovations and the addition of 6-12 stores annually. Morningstar DBRS expects the Company to stop paying dividends in the near term, following its privatization. As such, dividends are expected to be $16 million, which is attributable to H1 2024, before discontinuing over the forecast period. As a result, free cash flow before changes in working capital is expected to be relatively flat at approximately $70 million in 2024 and grow toward $85 million in 2025. Morningstar DBRS expects the Company to begin deleveraging through mandatory debt repayments of approximately $30 million per annum, and its excess cash flow sweep. In addition, Morningstar DBRS anticipates the Company will have principal lease payments of $35 million to $40 million annually in 2024 and 2025. As a result, Morningstar DBRS anticipates Sleep Country's key credit metrics will strengthen towards a level more appropriate for the current rating category in 2025 and continue to strengthen over the medium term.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental/Social/Governance factor(s) 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 Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)

A) Weighting of BRA Factors
In the analysis of Sleep Country Canada Holdings Inc., the relative weighting of the BRA factors was approximately equal.

B) Weighting of FRA Factors
In the analysis of Sleep Country Canada Holdings Inc., the relative weighting of the FRA factors was approximately equal.

C) Weighting of the BRA and the FRA
In the analysis of Sleep Country Canada Holdings Inc., the BRA and the FRA carry approximately equal weight.

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 (August 14, 2024)
https://dbrs.morningstar.com/research/437891

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 (April 15, 2024)
https://dbrs.morningstar.com/research/431186

Morningstar DBRS Criteria: Approach to ESG Factors in Credit Ratings (August 13, 2024)
https://dbrs.morningstar.com/research/437781

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.

A provisional credit rating is not a final credit rating with respect to the above-mentioned securities and may change or be different than the final credit rating assigned or may be discontinued. The assignment of the final credit ratings on the above-mentioned securities are subject to receipt by Morningstar DBRS of all data and/or information and final documentation that Morningstar DBRS deems necessary to finalize the credit ratings.

The credit rating was not initiated at the request of the rated entity. The credit rating was initiated at the request of a third party.

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 https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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