| DBRS is confirming the commercial paper, notes and debentures, and convertible unsecured subordinated debentures ratings of the Hudson's Bay Company (HBC or the company) as stated above. Results from the first half of F2003 have been below expectations, primarily due to poor seasonal sales at Zellers and higher clearance activity relating to unseasonal weather in May. While the shortfall was not material in its size, it is an indicator that causes concern and raises issues over the company's ability to recover earnings in the second half. The company's near-term liquidity position remains reasonable and long-term liquidity will be dependent on badly needed earnings recovery. Management has carried through on several stated objectives, such as lowering inventory and reducing operating expenses that positively affected margins for the Bay. Management has also negotiated terms with suppliers that allow for better cash management. While Zellers faced declining margins in the first half of the year due to bad weather in May (resulting in excess clearance activity of seasonal merchandise), the Bay benefited from a more stable and rational industry, seeing margins more than double. DBRS, however, remains concerned with the company's ability to restore profitability, which has been weak due to two main structural issues: (1) Zellers (63 per cent of the company's first-half sales) operates on a discount format, but cannot offer consumers lower prices than Wal-Mart due mainly to low sales per square foot and weaker buying power. Wal-Mart's aggressive growth plans for Canada will make the environment even more competitive. Wal-Mart is also arguably the most formidable merchandiser in the world. Zellers is attempting to differentiate itself from Wal-Mart by offering private and captive brands. The long-term potential, however, remains to be proven, and the division continues to lose market share, especially in the apparel market –- the market in which Zellers hopes to differentiate itself from Wal-Mart. (2) The Bay has traditionally driven sales through deep discount promotions, weakening profitability. In F2002, the company had 24 "Scratch 'n Save" promotions, but has had only one in the first half of F2003, and the promotion has now been permanently discontinued. Even with the promotions in place, however, the Bay faced deteriorating market share over the past few years. The company's near-term liquidity position remains reasonable, but long-term liquidity depends on earnings recovery. The company has $425-million of long-term debt maturing in the next two fiscal years. Supporting this maturity schedule is the fact that free cash flow has improved in the first half, but further improvement will be needed. There is also a significant amount of real estate that could be sold in the future to cover cash needs ($38-million has been raised this year through sale/leaseback transactions, and HBC has expressed a willingness to sell up to $75-million by year-end). |
