DBRS Assigns Issuer and Recovery Ratings to Sears Canada, Upgrades Instrument Ratings

Pursuant to DBRS’s newly launched leveraged finance rating methodology, DBRS has assigned an issuer rating of BB for Sears Canada Inc. (Sears Canada or the Company) and upgraded the Company’s existing instrument ratings to BBB from BB. The trends remain Stable. In addition to estimating the probability of default, DBRS’s leveraged finance methodology includes consideration of recovery value in determining an instrument’s rating. Given their secured nature, Sears Canada’s debt instruments have been assigned RR1 recovery ratings to reflect DBRS’s estimation of greater than 90% recovery under a potential default scenario.

DBRS notes that Sears Canada’s BB Issuer Rating does not reflect the Company’s credit metrics, which, in combination with the Company’s national scale, multi-channel format and strong private brands, could likely support an investment-grade rating. Rather, the BB rating reflects: 1) the influence of struggling majority shareholder Sears Holdings Corporation (Sears Holdings) on the day-to-day decision-making and operation of Sears Canada (i.e., cost-cutting and reduced capital investment), which is affecting Sears Canada’s performance and, potentially, its long-term position in the market; and 2) the possibility that Sears Holdings could remove significant cash flow and/or capital from Sears Canada for the benefit of its own shareholders, which could result in reduced financial flexibility and/or deterioration of Sears Canada’s financial profile.

Sears Holdings, which owns 70% of Sears Canada, continues to see its relative position deteriorate in the United States, as it struggles to turn itself around. Underlying Sears Holdings’ problems is the continued focus on increasing shareholder returns versus brand and store reinvestment – which DBRS believes is due mainly to the Company’s majority shareholder’s intention to boost shareholder returns in the near term. Sears Holdings’ earnings continue their decline, as same-store sales deteriorate and mark-down activity continues to drive operating margins lower.

Sears Holdings continues to rely on cost-cutting to support earnings, by reducing staffing and marketing expenditures. DBRS believes this ongoing cost-cutting, combined with reduced capital reinvestment, will continue to hurt performance and affect Sears Holdings’ ultimate viability. DBRS remains concerned that the pressures facing Sears Holdings could influence decision-making at Sears Canada, ultimately risking Sears Canada’s long-term position in the marketplace. DBRS believes any improvement of the ratings depends on satisfactory mitigation of this key risk. DBRS also notes that while the ratings of Sears Canada are closely linked to the performance of Sears Holdings, there is not necessarily a direct relationship between the ratings of the two companies.

That said, DBRS notes that Sears Canada’s earnings are improving, although largely as a result of cost controls. Furthermore, Sears Canada’s revenue growth and margins continue to lag those of its peers. Although the Company is making an effort to improve same-store sales through various initiatives (including updated product assortments and services, targeted marketing, etc.), DBRS believes the level of reinvestment remains too low relative to peers and will continue to limit top-line growth. DBRS also believes that the rate of margin improvement seen over the last two years will continue to decrease going forward, as the impact of further cost-cutting diminishes. With cost reduction driving higher margins and cash flow, the Company has been able to reduce debt and improve credit metrics. DBRS notes, however, that the risks associated with Sears Holdings continue to be the primary driver of Sears Canada’s ratings; therefore, further improvement in credit metrics should not affect the Company’s ratings.

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