Sobeys Debt is Priced One Step Above Junk
Debt investors are losing faith Canadian grocer Sobeys Inc. can engineer a quick turnaround from its troubled foray into the country’s western market.
Sobeys long-term debt is trading near its lowest level in more than five years after credit firms placed the company’s rating, teetering one step above junk, under negative outlook earlier this year. The yield premium investors demand to hold Sobeys’ 2023 bond over government debt is more than 300 basis points, wide for a bond of its rating and duration, according to Patrick O’Toole, portfolio manager at CIBC Asset Management.
“The market is basically already saying, ‘You’re high yield,’ ” O’Toole said. CIBC holds Sobeys bonds. “If somebody does pull the trigger and downgrade them, they’ll probably widen further because there will be some forced sellers.”
Sobeys spokesman Andrew Walker declined to comment, saying by email the Stellarton, N.S.-based company is in its quiet period ahead of fiscal second-quarter 2017 earnings Dec. 14.
Canada’s No. 2 grocer by sales, with more than 1,500 stores in 10 provinces, has faced operational challenges integrating Safeway Inc.’s Canadian stores, acquired by parent Empire Co. in June 2013. Sobeys has reported $2.8 billion in goodwill impairments, wiping the remaining goodwill from its western business. It listed $6.2 billion in sales in the last quarter, a 1-per-cent year-over-year decline. It has also been losing market share on price competition.
“These challenges in the West were mainly self-inflicted and more compounded by a weak economy in the West,” François Vimard, Empire’s interim chief executive officer, appointed in July, said on a Sept. 15 earnings call. The company’s priorities are building sales, reducing costs and improving store-level execution, he said.
“We had lost some confidence that Sobeys would be able to turn things around within an acceptable time frame,” Michael Goldberg, the DBRS Ltd. analyst who rates the company, said by phone from Toronto. “We’re willing to give them another year to stabilize the earnings, but we also want to see an increase in operating income.”
DBRS, which put Sobeys on negative outlook in September, is looking for the company to reach $1 billion in earnings a year, or $250 million in a quarter, Goldberg said. Sobeys reported $225 million in earnings for the quarter ended Aug. 6, down from $303 million for the same period the previous year. He said same-store sales in western Canada have declined for three consecutive quarters.
S&P Global Ratings generally gives investment-grade companies up to two years to show improvement before a downgrade, according to analyst Alessio Di Francesco. But Sobeys, dropped to negative in March, could be banished to high-yield sooner if things don’t improve. With its BBB- rating reflecting operational challenges as opposed to debt load, he said, the company needs to become more competitive in discount pricing.
“When we look at some of their competitors in the market, they’ve had pretty good quarters,” Di Francesco said by phone from Toronto.
Loblaw Cos., the number one grocer in Canada, reported retail sales of $13.9 billion, a 1.3-per-cent increase year-over-year, in the most recent quarter. Its leverage ratio is 1.8 times debt to earnings, compared with Sobeys’s 3.5 times. Rated BBB with a stable outlook by S&P, Loblaw’s 2023 bond is trading with a spread of about 140 basis points, according to Bloomberg data.
CIBC’s O’Toole said a downgrade could offer an opportunity in Sobeys bonds, with spreads widening possibly another 50 to 75 basis points.
“We still think they have a decent business, their financials are still pretty respectable — at some point, they’ll turn things around out West,” he said. “But it may not come soon enough for the rating agencies’ liking.”