Dominion Bond Rating Service has downgraded the debt of Loblaw Cos. Ltd., as Canada's largest supermarket chain struggles to head off competition from its domestic rivals and from the expected launch later this year of Wal-Mart Supercentres.

DBRS, one of Canada's most respected debt-rating agencies, said it has downgraded Loblaw's medium-term notes and debentures to "A" from "A (high)," with negative implications.

Loblaw Cos. Inc. three-month trading.

"The downgrade reflects the continued weakness in earnings that has followed Loblaw's attempts to reposition the business in response to the continuing transformation of the Canadian retail landscape," DBRS said in a release. "The downgrade also reflects the diminished prospects for significant improvements in earnings in the near term as the Canadian grocery industry becomes increasingly competitive."

The downgrade may make it harder and more expensive for Loblaw to borrow money in future. More significantly, the downgrade is a slap in the face for a grocery chain that has dominated the Canadian marketplace for many years.

Loblaw is ultimately controlled by Galen Weston and his wife, former Ontario lieutenant-governor Hilary Weston.

Galen Weston is Canada's most important grocer. (Canadian Press)

Loblaw, along with rivals Sobeys Inc. and Metro Inc., is busy reorganizing its business to meet competition from Wal-Mart, the Arkansas retailer that has changed the North American retail landscape with its deep-discount pricing.

But Loblaw is also facing competition from its domestic rivals.

"The lower profits are obviously an issue and that's led to weaker credit metrics," said DBRS retail analyst John Chamberlain during a conference call. "And all of that stems from an attempt by Loblaw to reposition the business to better compete."

While there is a "Wal-Mart effect," most of Loblaw's competition remains domestic, Chamberlain said, noting gains made by Sobeys and Metro in central Canada and by Safeway in the West.

"Generally, the grocery business has been getting stronger over the past few years," said Chamberlain.

"For the longest time, Loblaw seemed to have this market almost to themselves, where they dominated with a far-better fresh food experience that most of the competition was able to offer."

 

 

 

 

Loblaw is so leery of the coming competition that it has cut its annual guidance. It now expects profit in 2006 to fall perhaps as much as five per cent below the $2.17 a share it earned in 2005, and down from a previous growth estimate of four to seven per cent.

About half of the drop will come from poor profits in the general merchandise section, about 20 per cent in additional costs from a 20-month supply-chain overhaul, and 20 per cent from pricing pressures in Quebec and the western provinces, Canadian Press said.

A significant part of Loblaw's problem comes from a reorganization of the supply-chain arm that went very badly wrong. The company has spent nearly two years trying to fix the problems that resulted.

"DBRS notes that Loblaw expected that the substantial investments associated with the repositioning would begin to generate significant earnings improvements during the second half of the 2006 fiscal year," DBRS added. "It now appears that the earnings recovery may be further delayed. The earnings shortfalls have in turn resulted in deterioration in key credit metrics."

Loblaw shares closed down 28 cents to $47.42 on the Toronto Stock Exchange Monday, not far off the 52-week low of $47.08.