Sobeys’ Debt-Fuelled Safeway Buyout Puts Rating at Risk
The deal will push leverage, or debt as a ratio of cash flow, to 4 times from 2.2 times, and beyond the limit of what Standard & Poor’s would typically consider investment-grade, Andrew Calder, a credit analyst at Royal Bank of Canada in Toronto, wrote in a note to clients. Sobeys has the lowest investment-grade rating of BBB- from S&P.
“They will fight tooth and nail to stay investment grade,” said David Stonehouse, a fixed income fund manager with AGF Investment Management Inc., which oversees C$37.6 billion of assets including Sobeys’ bonds. “For them to retain investment grade status they really have their work cut out for them.”
Relative yields on the company’s C$100 million of notes due February 2018 surged 40 basis points to 175 basis points, according to Royal Bank of Canada data. On average, investment-grade rated companies pay a yield of 117 basis points more than government benchmarks on debt maturing in five years, according to Bank of America Merrill Lynch index data.
Sobeys parent company, Stellarton, Nova Scotia-based Empire Co. (EMP/A), agreed to acquire Safeway’s Canadian stores yesterday for C$5.8 billion. It has arranged a C$1.825 billion term loan with Bank of Nova Scotia and plans to issue C$800 million of bonds.
“We are committed to an investment grade rating,” Empire Chief Executive Officer Paul Sobey said in a phone interview. “This investment has been done prudently with the right insertion of capital.”
DBRS Ltd., which rates Sobeys higher than S&P at BBB, said yesterday it’s reviewing the rating for downgrade and that a cut would remain limited to one level, citing the company’s deleveraging plan.
“Where I have virually 100 percent confidence is they’ll be able to throw up cash flow,” Stonehouse said. “And their stated priority will be directed to bondholders first so I’m very comfortable on that score. Even with the backup in the last little while, it’s pretty attractive -- we won’t be letting go of it.”
S&P has indicated Sobeys has “some latitude” within its investment-grade rating for “acquisition-driven” debt increases, RBC’s Calder said.
“A lot of other people can speculate, we can’t,” S&P analyst Donald Marleau said. He declined to comment further, citing the firm’s disclosure policy.
“They are leveraging their balance sheet for this acquisition and that inevitably makes the credit riskier for any bond investor and the spreads are reflecting that,” Roshan Thiru, a money manager at Manulife Asset Management Ltd., said in a phone interview from Toronto. “While a downgrade by S&P to sub-investment grade is possible, I think it is also possible that the rating agency might give Sobeys some leeway and time to delever.”
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