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Highlighting value in the 10-year part of the ATDBCN curve

| October 16, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

A favorable credit view of Alimentation Couche-Tard Inc. (ATDBCN, Baa2/BBB) is underscored by its solid margins relative to other grocers, as well as management’s ability to rapidly delever post acquisitions. ATDBCN has long used acquisitions as a growth vehicle, but their stronger margin and free cash flow profile allows for a much quicker pace of delevering relative to peers, most notably Kroger (KR –Baa1/BBB), while maintaining a much stronger credit profile than KR. Pre-pandemic, the relationship between the ATDBCN and KR in the 10-year part of the curve was +12 bp. Now, that relationship is +37 bp (g-spread) which is too wide. The dislocation makes the ATDBCN 2.95% 1/25/30 the most attractive bond within its capital structure; it should trade only +15 bp to +20 bp behind KR 2.2% 5/1/30, providing +17 bp to +22 bp of potential upside for the ATDBCN 10-year.

Exhibit 1: Grocer spread curve

Source: Bloomberg/TRACE, Amherst Pierpont Securities

No Real Needs to Tap the Market

With the new issue market still in high gear, many companies are taking advantage of investor demand to push out debt maturities and/or refinance higher coupon debt.  We note that ATDBCN currently has no debt maturing until 7/26/22.  Furthermore, given that the majority of the company’s outstanding debt was issued between 2017 and 2020, ATDBCN has no real high coupon debt that can be refinanced with the exception of its 4.5% 7/26/47 paper.  While ATDBCN tapped the market earlier this year, the issuance was in January (pre-pandemic), therefore the coupons are low and are in no real need of refinancing.  The proceeds from that issue were used to repay borrowings under the revolver, with the balance retained as cash on the balance sheet.  Additionally, there are no acquisitions that require funding since ATDBCN lost out to Seven & i Holdings for the Speedway assets.   Absent any large M&A activity, ATDBCN’s balance sheet cash, which stood at $3.3bn coupled with its free cash flow generation (close to $3.0bn) is more than ample to address any maturing debt if there were to be any disruption in the high grade new issue market.

Exhibit 2. ATDBCN vs. KR Margin and Credit Profile Comparison

Source: Company Reports; Amherst Pierpont Securities

Credit Metrics Indicative of Higher Ratings

With total leverage below 1.5x and interest coverage over 15x, an argument could be made that ATDBCN’s ratings are too low.  We note that in Moody’s last press release on the credit, they noted that an upgrade would be considered should ATDBCN sustain leverage below 2.0x and coverage above 8.0x.  While Moody’s makes adjustments to the credit metrics when assessing its rating, we note that ATDBCN has been within the parameters for an upgrade for over six months already.  Moody’s also noted that leverage should not exceed 3.0x after making large acquisitions.  We note that with the company’s last large acquisition, completed in 2017, leverage increased to 3.6x temporarily.

Additionally, S&P noted in August that it could raise the rating within the next 24 months if ATDBCN were to maintain adjusted leverage below 2.25x.  According to S&P, adjusted leverage now stands at 1.9x.  S&P noted that while its acquisitive growth strategy remains a key risk given how fragmented the convenience store segment is, management has a strong track record of integrating acquisitions and extracting higher than anticipated cost synergies.  ATDBCN has been successful with past acquisitions from procuring fuel and merchandise inventories at better pricing while reducing overhead costs. That said, acquisitions have been EBITDA accretive.  Furthermore, its acquisitions have been strategic and have expanded its scale while maintaining its market leading position amongst its convenience store competitors.

Acquisitions on the Horizon? 

Management noted on its last earnings call that deal flow has been relatively quiet since the pandemic hit.  ATDBCN reiterated that its strategy remains focused on driving significant and sustainable organic growth along with M&A, only when they think it can create shareholder value.  We believe management remains very disciplined when it comes to M&A and will walk away from a deal that does not fit its ROI parameters.  This was evident when ATDBCN refused to keep raising its bid for Speedway when Seven & i Holdings entered the bidding war.  Management noted that they believe acquisition opportunities will arise but plan to remain both patient and financially disciplined, with a focus on maintaining a strong and healthy balance sheet that will enable them to seize an opportunity if and when it arises.

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