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

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating, the Medium-Term Notes credit rating, and the Debentures credit rating of Loblaw Companies Limited (Loblaw or the Company) at BBB (high). Morningstar DBRS also confirmed Loblaw’s Second Preferred Shares credit rating at Pfd-3 (high). All trends remain Stable.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations and Stable trends reflect Loblaw’s strong operating performance over the last 12 months ended March 23, 2024, as well as Morningstar DBRS’ view that Loblaw continues to be very well positioned to navigate this environment of strained consumer purchasing power, considering the Company’s relatively inelastic product offering, a leading discount banner footprint, and strong private-label offering.

CREDIT RATING DRIVERS
Should Morningstar DBRS gain increased confidence that the Company will be able to maintain key credit metrics at levels acceptable for an A (low) credit rating on a normalized and sustainable basis (i.e., debt-to-EBITDA, excluding financial services, of less than 2.25 times (x)) supported by further growth in earnings and the continued strengthening of the Company’s business risk profile, Morningstar DBRS could take a positive credit rating action. Conversely; although unlikely, should Loblaw’s key credit metrics deteriorate for a sustained period (i.e., debt-to-EBITDA, excluding financial services, increase to more than 3.25x) as a result of either weaker-than-expected operating performance and/or more aggressive financial management, the credit ratings could be pressured.

EARNINGS OUTLOOK
Morningstar DBRS forecasts Loblaw’s consolidated revenues to increase to approximately $61.5 billion in 2024 and to more than $63.0 billion in 2025 from $59.5 billion in 2023. This is based on Morningstar DBRS’ expectation that food retail same-store sales growth will be in the low- to mid-single digits in 2024, reflecting moderating inflationary pressures on prices and the effects of strained consumer purchasing power on volumes, while also considering Loblaw’s high degree of discount banner penetration and benefits associated with Canada’s considerable population growth. The revenue growth forecast also incorporates Morningstar DBRS’ expectation that drug retail same-store sales will grow in the low- to mid-single digits in 2024, underpinned by continued strong prescription volume growth, which should benefit from the expansion of pharmacy clinics. Lastly, Morningstar DBRS notes that Loblaw’s revenue growth trajectory should benefit from Loblaw’s renewed efforts to grow its square footage share. Morningstar DBRS anticipates that EBITDA margins will continue to see some relatively modest improvement, driven by modest gross margin expansion, including through initiatives to reduce shrink and considering mix change benefits, while operating leverage gains are expected to offset inflationary pressures on selling, general and administrative expense, particularly because of wage increases. Consequently, Morningstar DBRS forecasts Loblaw’s consolidated EBITDA to grow to approximately $6.9 billion in 2024 and to more than $7.2 billion in 2025 from $6.6 billion in 2023.

FINANCIAL OUTLOOK
Morningstar DBRS believes Loblaw’s financial profile will continue to gradually strengthen in line with the projected growth in earnings, considering the Company’s strong free cash flow (FCF) generating capacity and relatively stable debt levels (excluding financial services). Morningstar DBRS anticipates that consolidated cash flow from operations will continue to track operating income, while capital expenditures and dividends are expected to average out to be higher than $2.0 billion and $600 million, respectively, in each of 2024 and 2025 compared with $2.1 billion and $560 million, respectively, in 2023. As such, Morningstar DBRS forecasts Loblaw’s consolidated FCF (as calculated by Morningstar DBRS, before changes in working capital as well as after net principal lease payments and dividends, and not accounting for any real estate dispositions) to continue to be comparable with 2023 levels of $1.4 billion. Morningstar DBRS believes the Company will continue to primarily use its FCF in combination with accumulated cash and potentially some incremental debt for share buybacks, such that key credit metrics remain relatively stable versus 2023 levels (i.e., debt-to-EBITDA, excluding financial services, just less than 2.25x), which are considered strong for the Company’s current credit rating.

CREDIT RATING RATIONALE
Loblaw’s credit rating continues to reflect the Company’s strong business risk profile, including its position as Canada’s largest food and drug retailer, while also reflecting the intense competition in Canadian food retail.

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

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of Loblaw, the relative weighting of the BRA factors was approximately equal.

(B) Weighting of FRA Factors
In the analysis of Loblaw, the relative weighting of the FRA factors was approximately equal.

(C) Weighting of the BRA and the FRA
In the analysis of Loblaw, the BRA carries greater weight than the FRA.

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