DBRS Morningstar Changes Trend on METRO INC. to Positive from Stable, Confirms Ratings at BBB

DBRS Limited (DBRS Morningstar) changed the trends on METRO INC.’s (Metro or the Company) Issuer Rating and Senior Unsecured Debt rating to Positive from Stable and confirmed the ratings at BBB. The trend changes reflect the gradual strengthening of Metro’s business risk profile since before the successfully integrated acquisition of Jean Coutu, which closed in 2018, as evidenced by the Company’s long-term track record of consistent same-store sales growth and margin expansion. Furthermore, the trend changes also reflect the long-term improvement in Metro’s key credit metrics, to a level supportive of a BBB (high) rating, through growth in earnings, combined with DBRS Morningstar’s expectation that the Company will be able to sustain key credit metrics at this level.

On December 9, 2021, DBRS Morningstar confirmed the Company’s ratings at BBB with Stable trends. At the time, DBRS Morningstar stated that, should Metro’s business risk profile materially strengthen and credit metrics improve, such that debt-to-EBITDA falls below 2.5 times (x) on a normalized and sustainable basis as a result of growth in operating income, DBRS Morningstar could take a positive rating action.

Since then, Metro extended its long track record of delivering solid operating performance. For the fiscal year ended September 24, 2022 (F2022), operating results continued to show strength in the context of an intensely inflationary period and an evolving Coronavirus Disease (COVID-19) pandemic environment. Sound food and pharmacy same-store sales growth, combined with expanding EBITDA margins, resulted in Metro’s EBITDA growing to $1.8 billion in F2022 from just above $1.7 billion in F2021. As a result of the growth in EBITDA, combined with a $150 million decrease in lease liabilities and, as estimated by DBRS Morningstar, pro forma a $250 million to $300 million notes issuance in early F2023, key credit metrics continued to strengthen in F2022, with debt-to-EBITDA improving to approximately 2.40x from 2.65x and EBITDA interest coverage and cash flow from operations as a percentage of debt, which are considered very strong for the current ratings, improving to above 13.00x and approximately 33.0%, respectively, from 12.19x and 28.0%, respectively, in F2021.

Going forward, DBRS Morningstar believes that Metro’s operating performance could be pressured because of some near-term headwinds related to persistent inflation and an overall challenging macroeconomic backdrop due to decreasing consumer spending. That said, given the relatively inelastic nature of Metro’s product offering combined with its solid footprint of discount banners and private label offerings, DBRS Morningstar believes Metro is well positioned to navigate this period. Over the more medium term, DBRS Morningstar expects the Company’s earnings profile to continue to strengthen, supported by sound same-store sales growth and a gradual margin expansion. DBRS Morningstar forecasts sales to grow toward $20 billion in F2023, benefitting from sound food and pharmacy same-store sales growth as well as a 53rd week, and to well above $20 billion in F2024, from $18.9 billion in F2022. DBRS Morningstar expects Metro to be able to pass on some input costs and wage increases through pricing and benefit from an increase in higher-margin private label and pharmacy sales, resulting in EBITDA margins remaining relatively stable in F2023. As such, DBRS Morningstar believes Metro's EBITDA will grow to approximately $1.9 billion in F2023 and to approximately $2.0 billion in F2024, from $1.8 billion in F2022.

DBRS Morningstar expects Metro’s financial profile to remain relatively stable going forward. This is based on DBRS Morningstar’s view that, despite meaningfully increased capital expenditures (capex) and continued share buybacks, which will likely require some incremental debt issuances, the Company’s credit metrics will remain relatively stable, benefitting from growth in earnings. DBRS Morningstar forecasts cash flow from operations (as calculated by DBRS Morningstar) to track operating income and to be approximately $1.4 billion in F2023, and to grow to approximately $1.5 billion in F2024. Capex is projected to substantially increase to approximately $800 million in F2023 and to remain elevated through F2024, before decreasing thereafter. The increased capex is primarily related to the Company’s efforts to modernize its supply chain, including the automated distribution centres in Ontario and Québec. Cash outlay for dividends is expected to grow toward $300 million over the next two years. As such, DBRS Morningstar believes free cash flow (FCF) after dividends but before changes in working capital and net lease principal payments will remain above $350 million in F2023 and F2024. After changes in working capital and net lease principal payments, DBRS Morningstar expects the Company to primarily use its FCF and likely some incremental debt for share buybacks.

Should Metro continue to deliver operating performance generally in line with DBRS Morningstar’s expectations while maintaining relatively stable credit metrics, DBRS Morningstar will likely upgrade the ratings to BBB (high) over the course of the next year. Conversely, should credit metrics deteriorate (i.e., debt-to-EBITDA rises to above 2.50x on a sustained basis, along with a similar decline in the Company’s other credit metrics), as a result of either weaker-than-expected operating performance and/or more aggressive financial management, DBRS Morningstar could change the Positive trend on the ratings to Stable.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

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

The principal methodology is Global Methodology for Rating Companies in the Merchandising Industry (September 2, 2022; https://www.dbrsmorningstar.com/research/402334), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223/interplay-of-global-corporate-finance-rating-methodologies-when-analyzing-corporate-finance-transactions.

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.

This rating was not initiated at the request of the rated entity.

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.

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

DBRS Morningstar will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrsmorningstar.com.

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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