DBRS Morningstar Confirms Loblaw Companies Limited at BBB (high), Stable

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating, Medium-Term Notes rating, and Debentures rating of Loblaw Companies Limited (Loblaw or the Company) at BBB (high) as well as its Second Preferred Shares Rating at Pfd-3 (high), all with a Stable trends. DBRS Morningstar also discontinued and withdrew Loblaw’s Short-Term Issuer Rating, noting that the discontinuation does not reflect any change in DBRS Morningstar’s view of the Company’s credit quality. The confirmations and Stable trends reflect Loblaw’s robust operating performance in the context of an evolving pandemic environment, as evidenced by sound same-store sales growth on a two-year basis combined with EBITDA margin recovery. Loblaw’s ratings continue to reflect the Company’s strong business risk profile, including its position as Canada’s largest food and drug retailer, while also considering the intense competition in Canadian food retail.

Since DBRS Morningstar’s last rating action (see the press release dated September 17, 2020), Loblaw has reported results for four quarters (H2 2020 through H1 2021) that show operating results continue to be heavily affected by the Coronavirus Disease (COVID-19) pandemic.

In H2 2020 (ended on January 2, 2021), revenue increased 10.3% year over year (YOY), rising to almost $29.0 billion, driven by 6.9% and 8.6% food retail same-store sales growth in Q3 2020 and Q4 2020, respectively, and 6.1% and 3.7% drug same-store sales growth in Q3 2020 and Q4 2020, respectively, while also benefiting from an additional week. EBITDA margins declined approximately 7 basis points (bps) YOY to 9.8%, with coronavirus-related costs around the health and safety of customers and employees combined with unfavourable mix shift, more than offsetting operating leverage gains. However, given the significant growth in revenue, EBITDA increased 9.6% to approximately $2.8 billion YOY during H2 2020.

In H1 2021 (ended on June 19, 2021), operating results started to lap the elevated sales volumes experienced during H1 2020; however, revenue still increased 2.6% YOY to nearly $24.4 billion, given flat food retail same-store sales and 3.8% drug retail same-store sales growth as well as 11 net new store openings over the past 12 months. EBITDA margins increased by approximately 148 bps YOY to 10.6%, benefitting from lower coronavirus-related costs around the health and safety of customers and employees—which decreased to approximately $70 million from $282 million in H1 2020—operating leverage gains, and improvements in mix. As such, EBITDA grew 19.1% to almost $2.6 billion YOY during H1 2021.

Loblaw continued to generate substantial free cash flow (FCF, as calculated by DBRS Morningstar, after changes in working capital but before principal lease payments) of $2.5 billion during the last 12 months ended June 19, 2021 (LTM 2021), which the Company, in combination with some cash on hand, primarily used for $1.3 billion in net share repurchases (as calculated by DBRS Morningstar), $1.0 billion in operating lease payments, and $0.8 billion in debt repayments largely related to the Financial Services business. As such, combined with the growth in EBITDA, key credit metrics (as calculated by DBRS Morningstar, excluding the Financial Services business) improved notably, with debt-to-EBITDA improving to 2.65 times (x) for the LTM 2021 versus 2.96x (adjusted for the timing of the June 2020 refinancing) for the LTM 2020.

Looking ahead, DBRS Morningstar expects Loblaw’s earnings profile to remain supportive of the Company’s current ratings. For the full-year 2021, DBRS Morningstar forecasts revenue to decline, given the economic reopening and considering that H2 2020 benefitted from an additional week as well as strong sales volumes because of pandemic conditions, but remain well above $52.0 billion (versus $52.7 billion in 2020 and $53.3 billion during the LTM 2021). DBRS Morningstar forecasts EBITDA for the full-year 2021 to be approximately $5.4 billion (versus $5.0 billion in 2020 and $5.4 billion during the LTM 2021), as it expects that inflationary pressures will be offset by lower coronavirus-related costs and believes that the Company will pass on at least some of the inflation-driven cost increases through pricing. Looking further out, DBRS Morningstar predicts inflationary pressures from input cost and wage increases to persist, and while it believes that Loblaw can pass on some of these increases through pricing, the Company’s operating results could be hindered by these pressures depending on their degree and duration. That said, DBRS Morningstar forecasts Loblaw’s revenue for 2022 to grow to approximately $53 billion and EBITDA to grow to approximately $5.5 billion and notes that the Company has ample room within the context of the current ratings to absorb inflation driven pressures on operating results.

DBRS Morningstar expects Loblaws’ financial profile to remain appropriate for the current ratings, supported by the Company's FCF generating capacity combined with the expectation of relatively stable debt levels. DBRS Morningstar believes that cash flow from operations will continue to track operating income, while capital expenditures will be in the $1.2 billion range in 2021 and 2022. DBRS Morningstar expects dividends on a per-share basis to continue to grow, but given the Company’s share buybacks, total dividend outlays will likely be approximately $500 million in 2021 and 2022. As such, DBRS Morningstar forecasts Loblaw’s FCF (before working capital changes and principal lease payments) to be well above $2.0 billion in 2021 and 2022. DBRS Morningstar believes the Company will continue to use its FCF to buy back $1.1 billion of shares in 2021 and 2022, with the majority of the balance accounting for lease principal payments. Consequently, credit metrics should remain appropriate for the Company’s current ratings (i.e., adjusted debt-to-EBITDA of below 3.25x on a sustained basis). Although unlikely over the medium term, DBRS Morningstar could take a positive rating action should Loblaw’s business risk profile strengthen and credit metrics improve, such that debt-to-EBITDA improves to approximately 2.0x on a normalized and sustainable basis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodologies are Rating Companies in the Merchandising Industry (July 26, 2021; https://www.dbrsmorningstar.com/research/382073) and DBRS Morningstar Criteria: Rating Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 2, 2020; https://www.dbrsmorningstar.com/research/369165), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

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.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577