DBRS Comments on Sobeys Q3 F2016 Results

DBRS Limited (DBRS) today notes that Sobeys Inc. (Sobeys or the Company) reported Q3 F2016 results that were well below expectations. Revenues of $6.0 billion increased 1.5% year over year (YOY), based on 0.6% same-store sales (excluding fuel), and adjusted EBITDA decreased 19.9% YOY, significantly underperforming peers. These results are particularly weak considering healthy food inflation in Canada over this period. The challenges are mainly related to continued integration issues with Canada Safeway (Safeway) that resulted in store-level disruptions as well as increased merchandising and promotional programs that were not well received at Safeway. Sobeys’ same-store sales in Western Canada were -2.9% in Q3 2016. While DBRS recognizes the difficult market conditions in the west, DBRS believes that the Company has lost market share. Furthermore, as the challenges are likely to persist for longer than expected, Sobeys has taken an impairment of $1.7 billion to goodwill and long-term assets.

On August 17, 2015, DBRS confirmed Sobeys’ Issuer Rating and Senior Unsecured Debt rating at BBB (low) with Stable trends. At that time, DBRS stated that it expected revenue to grow to more than $24.6 billion, based on same-store sales growth in the 2% range, and EBITDA to increase to above $1.2 billion in F2016. Furthermore, DBRS expected Sobeys’ credit metrics to continue to improve, primarily as a result of steady increases in operating income, such that lease-adjusted debt-to-EBITDAR would drop comfortably below 3.0 times (x) and lease-adjusted EBITDA coverage would increase toward 6.0x. DBRS stated that should it become confident that metrics would be sustained at these levels, Sobeys’ ratings would be more appropriately placed in the BBB rating category.

Following the release of Q3 F2016 results, DBRS now believes sales to be slightly over $24 billion and EBITDA to decrease to less than $1.1 billion. While this will affect cash flow, DBRS expects that free cash flow after dividends will remain meaningfully positive at approximately $300 million (versus previous estimate of $460 million). As the Company’s debt balance is expected to be relatively steady, DBRS now forecasts lease-adjusted debt-to-EBITDAR to be in the 3.3x range and lease-adjusted EBITDA coverage to be approximately 5.5x at the end of F2016, taking Sobeys off course for a positive rating action.

The Company intends to rebuild its top-line sales in Western Canada through promotional activity, focusing on produce. This strategy could have a negative impact on margins and operating income over several quarters and may incite a response from competitors; however, the Stable trend reflects DBRS’s view that Sobeys has the capacity to withstand continued pressure from the Safeway business over this time in its current rating category (lease-adjusted debt-to-EBITDAR toward 4.0x). Any positive rating action over the longer term would require growth in earnings as opposed to an improvement in credit metrics through debt reduction.

Sobeys’ ratings continue to be supported by its number two position in the Canadian food retailing market and its diversification across the country, balanced by intense competition and execution risks associated with its turnaround strategy in Western Canada.

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

The applicable methodology is Rating Companies in the Merchandising Industry, which can be found on our web site under Methodologies.

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