DBRS Confirms METRO INC. at BBB, Stable Trends

DBRS Limited (DBRS) confirmed the Issuer Rating and Senior Unsecured Debt rating of METRO INC. (METRO or the Company) at BBB as well as its Short-Term Issuer Rating at R-2 (middle). All trends are Stable. The confirmation is based on the Company’s stable operating performance in food retail through the end of Q3 F2018 and acknowledges the closing of the Jean Coutu Group (Jean Coutu) acquisition on May 11, 2018. METRO’s ratings continue to be supported by its solid market positions, diversified store formats and banners as well as disciplined financial management. The Company’s ratings also reflect the intensely competitive environment and its geographic concentration in Ontario and Québec, its exposure to generic drug-pricing reforms and the risk of more aggressive financial management.

METRO’s earnings profile should remain stable at a level considered appropriate for the current rating, despite intense competition in food retail and meaningful near-term headwinds, including minimum-wage increases, tariffs, rising transportation costs and generic drug-pricing reforms. DBRS notes that F2019 will be the first year to fully consolidate the Jean Coutu acquisition, which will result in a meaningful increase in net sales. Net sales on a fully consolidated basis should increase in the low-single digit range per year over the medium term (versus prior results pro forma the acquisition) based primarily on same-store sales growth. DBRS forecasts food same-store sales growth in the low-single digit range over the near to medium term, driven primarily by price increases as the Company seeks to pass on rising costs to customers in a competitive environment. Pharmacy same-store sales growth is expected to be in the low- to mid-single digit range over the near to medium term, driven by front-store sales and increased prescription count, but partially offset by a decline in prescription value. DBRS believes EBITDA margins may come under pressure in the near term because of rising costs (i.e., minimum wage, tariffs and transportation) and generic drug-pricing reforms, which METRO will seek to largely offset with price increases (to the extent possible in this competitive environment) and continued efficiency improvements. Over the medium term, EBITDA margins should benefit from the achievement of synergies after the acquisition of Jean Coutu (i.e., procurement, selling, general and administrative expenses and distribution), which the Company estimates will be approximately $75 million three years after closing. As such, DBRS expects METRO’s EBITDA to remain relatively flat at approximately $1.3 billion in the near term, rising toward $1.4 billion over the medium term.

DBRS believes METRO’s financial profile will remain stable over the near to medium term as the Company reaches its stated leverage target of adjusted net debt-to-EBITDAR of 2.5 times (x) after the Jean Coutu acquisition and shifts the allocation of its free cash flow from debt repayment to increasing shareholder returns. Cash flow from operations should track operating income while capital expenditures (capex) increase meaningfully above normalized levels in F2019 and F2020 to the $450 million to $500 million range as METRO invests in two new distributions centres in Ontario while continuing to invest in store renovations and conversions. The Company’s dividend policy should remain consistent, targeting a payout of 25% of prior-year net income. As a result, DBRS believes free cash flow after dividends and before changes in working capital should be in the $380 million to $430 million range over the medium term. As METRO reaches its stated leverage target toward the end of F2018 and into F2019, DBRS believes the Company will shift the primary use of its free cash flow from debt repayment to completing share repurchases. As such, DBRS expects key credit metrics will improve in the near term (i.e., lease-adjusted debt-to-EBITDAR of 2.7x in F2019 from pro-forma lease-adjusted debt-to-EBITDAR of 2.9x in the last 12 months ended Q3 F2018) and remain relatively stable thereafter at a level considered well placed for the current BBB rating (i.e., lease-adjusted debt-to-EBITDAR below 3.0x).

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

The principal methodology is Rating Companies in the Merchandising Industry, which can be found on dbrs.com under Methodologies.

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.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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