DBRS Morningstar Downgrades Canadian Tire Corporation to BBB with a Stable Trend, and Removes Ratings from Under Review with Negative Implications

DBRS Limited (DBRS Morningstar) downgraded the Issuer Rating and Medium-Term Notes rating of Canadian Tire Corporation, Limited (CTC or the Company) to BBB from BBB (high), with Stable trends. This action removes the ratings from Under Review with Negative Implications where they were placed on April 7, 2020. DBRS Morningstar’s decision to downgrade CTC’s ratings is based on the expectation that it will not fulfill its previous commitment to reduce leverage to below 2.5 times (x) during 2020. The Stable trend reflects DBRS Morningstar’s expectation that credit metrics will improve to a level supportive of a BBB rating by the end of 2021 following the Coronavirus Disease (COVID-19) pandemic and its macroeconomic after effects.

DBRS Morningstar’s March 29, 2019, confirmations of CTC’s ratings at BBB (high) with Stable trends were based on the expectation that lease-adjusted debt-to-EBITDA attributable to the Retail and CT Real Estate Investment Trust (CT REIT) segments would return to a level more appropriate for a BBB (high) rating category by 2020 (i.e., below 2.5x), following its debt-financed acquisition of Helly Hansen on July 3, 2018. This view was based on DBRS Morningstar’s expectation that the Company would deleverage, primarily as a result of increasing operating income and stable debt levels.

Since then, CTC’s earnings improved modestly on the back of revenue growth and stable margins (excluding the impact of IFRS 16) in 2019. This, in turn, resulted in leverage attributable to the Retail and CT REIT segments improving to 2.64x from 2.77x in 2018. However, leverage remained at a level that was not commensurate with the BBB (high) rating category.

In contrast with its previous expectations outlined in 2019, DBRS Morningstar forecasts that CTC’s 2020 credit metrics will be distressed due to the coronavirus pandemic. Revenue and operating income will decline significantly due to temporary store closures, the impact of ongoing social distancing requirements, and a weaker macroeconomic environment, which will continue to pressure consumer spending. DBRS Morningstar forecasts margins and operating income to materially contract due to an uptick in lower-margin digital sales volumes and incremental store operating costs, which will only be partially offset by benefits from cost-saving initiatives. Consolidated margins and operating income will also be pressured by revenue contraction and higher credit loss allowances in the Canadian Tire Financial Services (CTFS) segment. As such, consolidated EBITDA is forecast to be approximately $910 million, of which an estimated $785 million is attributable to the Retail and CT REIT segments, and the remaining $125 million to the CTFS segment. However, these forecasts are more dynamic than usual due to the uncertainty surrounding the macroeconomic outlook. DBRS Morningstar believes that the decline in operating income and negative free cash flow (FCF) will temporarily weaken CTC’s financial profile beyond the range considered appropriate for the BBB rating category. While the Company has deferred discretionary capital expenditure and paused share buy-backs, gross debt is forecast to increase by approximately $200 million in 2020. As such, leverage attributable to the Retail and CT REIT segments is forecast to be 5.76x, compared with 2.64x in 2019.

In 2021, DBRS Morningstar forecasts that revenue attributable to the Retail and CT REIT segments will be lower than 2019 levels by mid-single digits, mainly attributable to high unemployment/weaker consumer spending, which is expected to particularly pressure CTC’s discretionary banners/categories, as well as reduced travel, which would negatively affect the Petroleum segment. Retail and consolidated EBITDA margins are forecast to be lower than 2019 due to the impact of higher digital sales volumes and operating costs. DBRS Morningstar also anticipates that CTFS’s provisioning levels will remain conservative in 2021, further contributing to margin erosion. As such, consolidated EBITDA is forecast to be approximately $1.6 billion in 2021, of which an estimated $1.39 billion is attributable to the Retail and CT REIT segments and the remaining $215 million is attributable to CTFS. (In 2019, EBITDA generated by the Retail and CT REIT segments was approximately $1.63 billion and the CTFS segment generated approximately $440 million of EBITDA.)

In terms of the Company’s financial profile, DBRS Morningstar expects CTC to be FCF positive (after dividends) in 2021. This, combined with any proceeds from the divesture of a portion of its stake in CT REIT may enable the Company to reduce its gross debt balance. As such, leverage attributable to the Retail and CT REIT segments is forecast to be between 3.0x and 3.25x at the end of 2021. The Stable trend reflects DBRS Morningstar’s expectation that credit metrics will improve further beyond 2021 (i.e., debt-to-EBITDA attributable to the Retail and CT REIT segments toward and below 3.0x), based primarily on growth in operating income. However, if CTC’s operating performance deteriorates beyond current expectations, a negative rating action could result, regardless of capital-conserving measures undertaken by the Company to improve credit metrics through debt reduction. Additionally, any debt-funded acquisitions could also lead to a negative rating action.

DBRS Morningstar notes that CTFS’s asset quality is expected to worsen over the course of 2020 as customers defer and/or default on their credit card balances. However, DBRS Morningstar acknowledges that CTFS’s conservative provisioning levels are in line with industry peers, and expects that this trend will continue in the near to medium term. That said, DBRS Morningstar believes that CTFS’s earnings will begin to recover from 2020 and 2021 lows, which has been incorporated in CTC’s BBB rating.

CTC’s ratings continue to reflect its strong brands and market positions, geographic diversification, and real estate ownership and control through CT REIT. The ratings also reflect the intense competition, risks related to CTC’s ambitions for growth, and the cyclical financial services business.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodologies are Rating Companies in the Merchandising Industry (August 15, 2019), Global Methodology for Rating Banks and Banking Organisations (June 11, 2019), and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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@dbrsmorningstar.com.

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

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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