TEXT-S&P affirms Loblaw, George Weston 'BBB' ratings

Thu Dec 6, 2012 1:15pm EST

Overview
     -- We are affirming all our ratings on Toronto-based Loblaw Cos. Ltd.
 and George Weston Ltd., including our 'BBB' long-term corporate
credit rating on each company, following Loblaw's announcement that it intends
to contribute about C$7 billion of real estate assets into a publicly traded
real estate investment trust (REIT).
     -- We expect that management will make financing and ownership decisions 
to capitalize the Loblaw retailer and REIT in a manner that keeps consolidated 
credit measures in line with the 'BBB' rating.
     -- We estimate that the proposed changes will have a limited effect on 
consolidated profitability and cash flow measures, with negative cash flow 
consequences restricted to the net of Loblaw rents and REIT investment returns 
to Loblaw.
     -- The stable outlook reflects Standard & Poor's expectation that steady 
operating performance would enable Loblaw to maintain its investment-grade 
financial risk profile despite ongoing pressures, such as intensifying 
competition and continuing large store-level and supply-chain investments.

Rating Action
On Dec. 6, 2012, Standard & Poor's Ratings Services affirmed all of its 
ratings on Toronto-based Loblaw Companies Ltd. and parent George Weston Ltd., 
including its 'BBB' long-term corporate credit rating on both companies. The 
outlook is stable.

The affirmation follows Loblaw's announcement that it plans to contribute 
about C$7 billion of real estate assets into a publicly traded real estate 
investment trust (REIT). Loblaw intends to retain a significant majority 
interest in the REIT, which we view as a key determinant for the ratings.

The affirmation reflects our expectation that Loblaw's financial risk 
profile--and by extension George Weston's--would remain consistent with the 
'BBB' rating on both companies. We expect that management will make financing 
and ownership decisions to capitalize the Loblaw retailer and REIT in a manner 
that keeps consolidated credit measures in line with the rating. We believe 
the proposed REIT and the real estate that it owns will remain core to Loblaw 
and George Weston, even if a minority position is sold to public investors. 
The real estate being contributed is deemed integral to the strategy of 
supporting retail activities, considering that initially the REIT will own 
about 75% of Loblaw's real estate and that Loblaw will account for the 
overwhelming majority of REIT net operating income (NOI). 

Although we believe that Loblaw's ownership percentage and NOI concentration 
could decline as the REIT accesses public markets to fund growth in its 
non-Loblaw portfolio, we expect that it is highly unlikely that the REIT will 
be sold outright, and that Loblaw's ownership will remain elevated enough to 
ensure control. Moreover, we expect that Loblaw's long-term commitment to real 
estate is enhanced by the quality of the real estate portfolio and the group's 
capacity to support it financially.

Rationale
The ratings on Loblaw reflect Standard & Poor's view of the company's 
satisfactory business risk profile, characterized by its position as the 
largest grocer in Canada with leading market shares in all regions it serves 
and a well-established private-label program. We believe these strengths are 
partially offset by weaknesses in the company's operating infrastructure that 
have contributed to significant incremental capital and operating expenditures 
amid challenging market conditions.

We view the real estate transaction as consistent with Loblaw's and George 
Weston's currently moderate financial policies, primarily because of the 
long-term stability expected in the group's consolidated financial risk 
profile. We believe that the imputed decline in Loblaw's stand-alone 
profitability from lease payments will be offset by a long-term shift in 
borrowings from Loblaw to the REIT. That said, our analytical consolidation of 
the REIT supports our rating on Loblaw, because we expect Loblaw's higher 
lease-adjusted leverage on a stand-alone basis to be offset largely by stable 
cash distributions from the REIT, given Loblaw's retention of a significant 
portion of the REIT's capital structure. 

We rate Loblaw and its 63% owner, George Weston, the same, but the ratings are 
linked, not equalized, whereby each rating is jointly influenced by the 
respective company's credit profile. The current linkage between the two 
companies is direct, because Loblaw accounts for the vast majority of George 
Weston's consolidated earnings, and Loblaw's financial performance is the 
primary determinant of George Weston's. Furthermore, we believe that Loblaw's 
equity value would affect George Weston's financial flexibility. That said, 
the ratings on the two companies could differ by up to one notch given the 
current capital structures.

Loblaw is well-positioned among grocery retailers, with the industry's 
broadest offering that covers all market segments in all regions. 
Nevertheless, we believe the company's breadth exposes it--and particularly 
its large hard-discount format--to increasing competitive pressure as Wal-Mart 
Stores Inc. (AA/Stable/A-1+) ramps up its grocery offering in Canada and 
Target Corp. (A+/Stable/A-1) launches in Canada in 2013. Loblaw's last 12 
months' (LTM) revenue growth increased 1.7% year-over-year, which is the 
lowest among its direct peers, although we do not believe this necessarily 
indicates any notable decline in Loblaw's market share, in part because of the 
company's shift away from higher-ticket, lower-margin general merchandise. 
Loblaw's LTM reported EBITDA margin has declined about 25-30 basis points 
since late 2011, reflecting lower food price inflation in 2012 and higher 
selling, general, and administrative expenses.

We believe that lower food price inflation and continuing intense competition 
into 2013 could stagnate the revenue growth for supermarkets in Canada, 
potentially translating into margin pressure. Moreover, we expect that a 
modest escalation of price competition is inevitable, as Wal-Mart and Target 
aim to capture a sizable portion of the market's growth in Canada. That said, 
we believe that the Canadian incumbents are well-positioned to withstand their 
competitors' aggressive square footage growth and pricing, not least of which 
because of their long-standing, attractive locations.

Consumers continue to shift toward discount stores, private label products, 
and home meal replacements as lower-cost alternatives to full-service formats, 
national brands, and restaurant outings. Loblaw aims to capture this market by 
emphasizing its extensive private label program, as well as its national 
network of hard discount stores. Such a shift typically weakens revenue 
growth, but it would likely not have a meaningful impact on profitability 
because the company's private label products should generate better margins 
than its national brands. In addition, we believe the cost structure of 
Loblaw's discount stores is aligned to its lower-price strategy, leading to 
profitability similar to that of its conventional and superstore formats.

The company's credit metrics are consistent with the rating, and have improved 
meaningfully in the past two years along with benign market conditions for 
grocers in Canada, as well as Loblaw's operational improvements. As of Oct. 6, 
2012, LTM adjusted debt to EBITDA was steady year-over-year at 2.8x, while 
adjusted EBITDA interest coverage has improved modestly to 6.2x. Assuming 
1%-2% revenue growth for 2012 and 2013, consistent with our views on Canada's 
GDP growth and Loblaw's modest growth plans, and assuming 6.5% reported EBITDA 
margins, we estimate that Loblaw could maintain leverage of about 2.9x through 
2013. That said, we believe that our margin assumption could face some 
pressure through 2013 amid continued heavy expenditures on restructuring 
activities, potential operational risks, and intense competition.

The creation of the REIT does not alter our view of Loblaw's intermediate 
financial risk profile, despite some meaningful changes expected in its 
capital structure and financing strategies. We estimate that the proposed 
changes will have a limited effect on consolidated profitability and cash flow 
measures, with negative cash flow consequences restricted to the net of Loblaw 
rents and REIT investment returns to Loblaw, which we estimate should preserve 
funds from operations to debt within a range of 25%-27% in the next several 
years on a consolidated basis. We believe that the overarching risk to 
Loblaw's profitability and cash flow protection remains the high transitional 
costs to support IT and supply chain technology investments. We expect costs 
to drop at the outer end of our rating horizon in two years, which we believe 
could be a catalyst for a meaningful boost to Loblaw's free cash flow.

Liquidity
Loblaw's liquidity is strong. At Oct. 6, 2012, the company had C$1.6 billion 
in cash and short-term investments, C$243 million held as security deposits, 
and full availability on its C$800 million committed credit facility maturing 
in 2017. We do not incorporate into our liquidity assessment the prospective 
nature of sources and uses from any potential REIT transaction, but we expect 
that such a transaction will likely bolster Loblaw's currently strong 
liquidity position. Our view incorporates the expectation that the company 
will meaningfully exceed the following liquidity thresholds as defined by our 
methodology:
     -- Liquidity sources (including cash, discretionary cash flow, and 
availability under its revolving credit facility) will exceed uses by at least 
1.5x through 2013;
     -- Liquidity sources will continue to exceed uses, even if EBITDA were to 
decline by 30% in 2012 and 2013;
     -- Heavy capital expenditures and elevated operating costs could 
constrain free cash flow;
     -- Loblaw's maturities are modest, with US$150 million due in May 2013 
and C$200 million due in November 2013;
     -- The company has good relationships with its banks and a solid standing 
in capital markets; and
     -- We believe that Loblaw comfortably met the financial covenants under 
its committed credit facility at Oct. 6.

Outlook
The stable outlook reflects Standard & Poor's expectation that steady 
operating performance would enable Loblaw to maintain its investment-grade 
financial risk profile despite ongoing pressures, such as intensifying 
competition and continuing large store-level and supply-chain investments. 
Moreover, we expect the creation of a publicly traded REIT will be neutral to 
credit quality on a consolidated basis, with the REIT's moderate 
capitalization offsetting higher lease-adjusted debt at the Loblaw level. We 
believe that ratings stability is supported by the industry-leading breadth of 
Loblaw's retail platform and credit measures consistent with the ratings. The 
ratings could come under pressure if any combination of intense competition or 
operating disruptions weakened profitability, or if sharp unexpected increases 
in restructuring costs or capital expenditures contributed to a sustained rise 
in leverage approaching 3.5x. Notwithstanding the meaningful buffer in a 
downside scenario, an upward revision is unlikely in the 12-to-18-month 
horizon for our outlook for the rating, as internal challenges and REIT 
execution risks, as well as increasingly competitive conditions in the 
Canadian supermarket industry, will likely preclude significant improvements 
in credit measures.
Related Criteria And Research
     -- Key Credit Factors: Business And Financial Risks In The Retail 
Industry, Sept. 18, 2008
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
     -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
     -- Corporate Criteria--Parent/Subsidiary Links; General Principles; 
Subsidiaries/Joint Ventures/Nonrecourse Projects; Finance Subsidiaries; Rating 
Link to Parent, Oct. 28, 2004

Ratings List
Ratings Affirmed

Loblaw Cos. Ltd.
George Weston Ltd.
Corporate credit rating                BBB/Stable/--      

Loblaw Cos. Ltd.
 Senior unsecured debt                 BBB                
 Preferred stock                       P-3(High)          

George Weston Ltd.
 Senior unsecured debt                 BBB                
 Preferred stock                       P-3(High)          



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