DBRS Upgrades Sobeys to BBB with a Stable Trend

DBRS has today upgraded the Senior Unsecured Debt rating of Sobeys Inc. (Sobeys or the Company) to BBB from BBB(low); the trend is Stable. On June 26, 2009, DBRS changed the trend on the Company’s BBB (low) rating to Positive from Stable. That action reflected operating performance and financial management over the course of F2009 (i.e., the year ending May 2, 2009) that was more consistent with a BBB credit rating. Growth in operating income and cash flow, combined with debt reduction, resulted in lease-adjusted debt-to-EBITDAR of 2.3 times (x) and lease-adjusted cash flow-to-debt of almost 30% for F2009, which is better than our original expectations and significantly better than at the end of F2008 (2.7x and 26%, respectively).

In the June press release, DBRS stated that if Sobeys displayed traction by maintaining its recently achieved credit metrics through the first half of F2010, it would be comfortable upgrading the Company’s long-term rating to BBB. At that time, DBRS forecast sales growth of 3% to 3.5% and relatively stable margins for Sobeys in F2010. DBRS also expected that capex would remain at levels that keep free cash flow (after the dividend paid to its parent, Empire Company Limited (Empire)) in positive territory over the following couple of years. As such, we did not foresee a significant change in the absolute level of debt at Sobeys.

Sobeys just released results for Q1 F2010, and actual performance was stronger than DBRS’s expectations. Sobeys delivered above-industry-average same-store sales growth of 4.0% and overall revenue growth of 5.3% (to $3.91 billion). Sales growth resulted from price increases, improved market share and increased retail square footage (from new stores and enlargements). During the latest quarter, the Company opened, expanded, renovated, acquired and/or converted the banners in 22 stores. EBITDA margin improved further to 5.07% for Q1 F2010 from 4.91% year over year (yoy), resulting in EBITDA of $198 million (compared with $182 million in Q1 F2009). Margin performance reflects disciplined pricing and cost-management initiatives within the context of a competitive and food-inflationary environment. In terms of financial profile, Sobeys generated positive free cash flow (after dividends) of approximately $100 million and received proceeds from a sale-leaseback transaction of $51 million. This led to debt reduction of $75 million (to $882 million) and an increase in cash and equivalents of $68 million (to $293 million).

The better-than-expected financial performance in the opening quarter of F2010 improves trailing 12-month credit metrics slightly and provides DBRS with the comfort necessary to upgrade the rating to BBB at this time. DBRS believes Sobeys is well positioned to maintain credit metrics commensurate with its new rating category for at least the medium term.

DBRS notes again that debt at the Empire level must also be supported by earnings and cash flow from Sobeys and Empire’s other investments. Empire’s deconsolidated debt balance was $281 million at the end of Q1 F2010 versus $389 million at the end of F2008. The fact that debt held at the Empire level has declined to a fairly small amount relative to the debt at Sobeys and is structurally subordinated – in addition to the fact that Empire’s investments in real estate and other businesses are basically free cash flow positive – means that Empire has also contributed to the fundamental improvement in the credit risk profile at Sobeys.

Sobeys maintains a good variety of selling formats and is well diversified on a national basis. DBRS recognizes that investments in its store base over the past few years have helped Sobeys improve its competitiveness. DBRS also recognizes that the competitive environment has become more rational over the course of the past year, and the sector has benefited from the effects of food inflation and the economic downturn, as grocers benefit from increased at-home food consumption.

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

The applicable methodology is Rating Food Retailers, which can be found on our website under Methodologies.

This is a Corporate rating.