DBRS Changes Loblaw Companies Long-Term Trends to Negative

Dominion Bond Rating Service (“DBRS”) has today changed the trends on the Medium-Term Notes and Debentures of Loblaw Companies Limited (“Loblaw” or the “Company”) to Negative from Stable. The Negative trend change is a result of challenges related to the repositioning of the business to respond to the continuing transformation of the Canadian retail landscape. DBRS has also confirmed the Commercial Paper rating at R-1 (low) with a Stable trend.

DBRS notes that the Company’s repositioning efforts have included an increasing focus on general merchandise sales that has created several challenges. While Loblaw has a long history of running a general merchandise business in western Canada, the Company has encountered challenges in new territories. Firstly, the logistics for the general merchandise business have been difficult due to supply chain management issues. Secondly, the purchasing and merchandising expertise required to effectively compete in general merchandise is somewhat different than the skills required in the grocery business. Thirdly, Loblaw has less buying clout in the general merchandise field when compared to the primary international general merchandise competitors. While Loblaw has commenced various strategies to deal with these challenges, the Company has not yet been able to demonstrate that those initiatives will be successful. As general merchandise has been established as a key component of Loblaw’s ongoing strategy it is essential that these issues be resolved.

In addition to the issues related to the general merchandise business, Loblaw faces challenges in the core grocery business, including ongoing initiatives to reduce costs to better compete in an increasingly price-sensitive environment. These cost-saving initiatives have been multi-faceted and comprehensive. To date, the supply chain restructuring and systems conversion components of those initiatives have resulted in some lost sales as well as certain increases in short-term expenses. Although DBRS expects that these initiatives are prudent and will be beneficial in the long term, it remains to be proven that the short-term costs have concluded. In addition, Loblaw, like all unionized grocery retailers in North America, has a significant cost disadvantage when compared to non-union competition. This disadvantage is a result of both higher labour rates as well as less labour flexibility. Loblaw has worked proactively with its unions to try and address this cost; however, further progress will be required to fully address this challenge in the near term.

Notwithstanding these challenges, DBRS notes that Loblaw has numerous strengths including dominant market share in most regions of the country, a substantial portfolio on unencumbered real estate assets, a well-diversified portfolio of formats (RCSS, conventional grocery, hard discount and wholesale clubs), and an exceptionally strong private label program. All of these strengths provide Loblaw with significant advantages over conventional North American grocery retailers.

DBRS does not foresee liquidity issues arising in the near term despite the change in long-term rating trends as the Company retains a strong level of financial flexibility. In particular, Loblaw has consistently strong operating cash flow, ready access to capital markets, and a favourable maturity schedule. Accordingly, the trend on the Commercial Paper is maintained at Stable.