DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and the credit rating on the Medium-Term Notes of Canadian Tire Corporation, Limited (CTC or the Company) at BBB, both with Stable trends, after today's announcement of the Company's reacquisition of The Bank of Nova Scotia's (rated AA with a Stable trend) 20% stake in CTFS Holdings Limited (CTFS) (the Reacquisition).
This $895 million Reacquisition, which restores CTC's full ownership of CTFS, will be funded by the Company's existing short-term credit facilities, supplemented by a $400 million 18-month term loan. In 2024, CTC will evaluate strategic alternatives for CTFS with consideration being given to its optimal ownership structure and driving sustainable value in the Triangle Rewards program and credit card portfolio.
DBRS Morningstar's April 24, 2023, confirmation of CTC's credit ratings with Stable trends acknowledged the Company's robust financial performance in 2022, and incorporated DBRS Morningstar's expectation that CTC had sufficient headroom within the BBB credit rating category to navigate the challenging macroeconomic environment. At that time, DBRS Morningstar projected consolidated EBITDA and EBITDA attributable to the Retail segment and CT Real Estate Investment Trust (CT REIT; rated BBB with a Stable trend) to decline to around $2.4 billion and $2.0 billion, respectively, in 2023, from approximately $2.7 billion and $2.1 billion, respectively, in 2022. Combined with DBRS Morningstar's expectation that incremental debt would be used to partially finance the Company's strategic growth objectives, DBRS Morningstar forecast debt-to-EBITDA attributable to the Retail segment and CT REIT to increase toward 2.5 times (x) in 2023 from around 2.2x in 2022, and stabilize at that level over the medium term, well within the 3.0x threshold considered appropriate for the current BBB credit rating.
Since then, the Company reported its results for the six months ended July 1, 2023 (H1 2023), in which the negative effect of the slowing demand for discretionary products on CTC's operating performance was more pronounced than DBRS Morningstar had expected. Consolidated revenue declined below $8.0 billion in H1 2023 from approximately $8.2 billion in the same period last year (six months ended July 2, 2022; H1 2022). This decline was primarily attributable to negative low-single-digit comparable sales in the Retail segment as the negative effects of inflation and high interest rates on consumer behaviour pressured CTC's discretionary product categories/banners, more than offsetting increased sales volumes of essential products and owned brands. These negative effects also more than offset higher interest and fee income in the CTFS segment. Year over year, consolidated EBITDA margins contracted by 60 basis points to 12.3%, pressured by higher operating costs associated with CTC's strategic growth initiatives, elevated supply chain costs and operating inefficiencies related to the fire at the A.J. Billes distribution centre, and increased promotions at some Retail banners, which more than offset the benefit of accelerated owned-brand penetration, moderating freight costs, and cost-saving and efficiency-improving initiatives. Larger credit-loss allowances at CTFS also pressured consolidated EBITDA margins. As such, and notwithstanding the modest uplift to H1 2023 Retail and consolidated EBITDA following a change in how CTC accounts for the margin-sharing agreement with its dealers, consolidated EBITDA declined below $1.0 billion in H1 2023, with slightly more than $700 million of that being attributable to the Retail segment and CT REIT, from approximately $1.1 billion and $800 million, respectively, in H1 2022.
Given the softening in CTC's operating performance, coupled with DBRS Morningstar's concerns that these pressures could persist in light of the challenging macroeconomic backdrop, DBRS Morningstar moderated its expectations of the Company's operating performance. DBRS Morningstar now expects CTC to end 2023 with consolidated revenue of approximately $17.3 billion, down from both its previous projection of $17.7 billion and the 2022 level of $17.8 billion. While consolidated revenue should recover in 2024, DBRS Morningstar expects it to remain below 2022 levels, although considerable uncertainty about the macroeconomic outlook remains. DBRS Morningstar's consolidated topline projections are based on the expectation that persistent weakness in CTC's discretionary banners/product categories, which comprise approximately two-thirds of the Company's total product offering, will continue to outweigh the benefits from higher sales volumes of essential products and owned brands, thus resulting in negative low- to mid-single-digit comparable sales. DBRS Morningstar remains of the view that changes in consumer behaviour, coupled with higher operating costs associated with CTC's strategic growth initiatives, will more than offset the benefit from higher owned-brand penetration, moderating supply chain costs, and cost-saving and efficiency-improving initiatives, thus further contracting Retail and consolidated EBITDA margins. Furthermore, DBRS Morningstar expects even larger credit loss allowances in the CTFS segment to further contribute to consolidated EBITDA margin erosion. As such, DBRS Morningstar now forecasts consolidated EBITDA of approximately $2.2 billion in 2023, less than both its previous projection of $2.4 billion and the 2022 level of $2.7 billion. Similarly, DBRS Morningstar expects EBITDA attributable to the Retail segment and CT REIT to moderate to between $1.8 billion and $1.9 billion in 2023, lower than its previous forecast of $2.0 billion and the 2022 level of $2.1 billion. Looking ahead to 2024, DBRS Morningstar forecasts consolidated EBITDA and EBITDA attributable to the Retail segment and CT REIT to recover, but still remain below 2022 levels.
These modestly weaker forecasts, combined with the $200 million incremental debt following the Company's September 2023 Medium-Term Notes issuance and the $895 million debt associated with the Reacquisition, could result in debt-to-EBITDA attributable to the Retail segment and CT REIT weakening to around 3.2x at the end of 2023, which is above the 3.0x threshold considered appropriate for the current credit rating category. However, looking ahead, DBRS Morningstar expects CTC to take a balanced approach to its financial management practices, including consideration of the optimal ownership structure of CTFS, that, together with DBRS Morningstar's projections of a recovery in EBITDA attributable to the Retail segment and CT REIT, should result in debt-to-EBITDA attributable to the Retail segment and CT REIT improving to below the 3.0x threshold at the end of 2024.
That said, if DBRS Morningstar becomes concerned that debt-to-EBITDA attributable to the Retail segment and CT REIT will remain above 3.0x for an extended period because of weaker-than-expected operating performance and/or more aggressive financial management, the credit ratings could be pressured. Furthermore, DBRS Morningstar notes that weaker-than-expected operating performance for a sustained period resulting in a more permanent shift of the Company's business risk profile could also result in the requirement to maintain stronger credit metrics to support the same credit rating.
CTC's credit ratings continue to reflect its strong brands and leading market position, geographic diversification, and real estate ownership and control through CT REIT. The credit ratings also reflect the intense competition, risks related to the Company's ambitions for growth, and its cyclical financial services business.
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/416784 (July 4, 2023).
Notes:
All figures are in Canadian dollars unless otherwise noted.
DBRS Morningstar applied the following principal methodology:
Global Methodology for Rating Companies in the Merchandising Industry (https://www.dbrsmorningstar.com/research/417461; July 21, 2023).
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
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.
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 credit rating was initiated at the request of the rated entity.
The rated entity or its related entities did participate in the credit rating process for this credit rating action.
DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.
This is a solicited credit rating.
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 credit ratings are under regular surveillance.
Information regarding DBRS Morningstar credit ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.
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CANADIAN TIRE CORPORATION, LIMITED 
