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May 24, 2002

CANADA: DBRS confirms ratings for Cara Operations

Dominion Bond Rating Service Ltd (DBRS) has confirmed the senior debt and commercial paper ratings of Canadian foodservice giant Cara Operations at BBB and R-2 (high), respectively, with stable trends. DBRS explained that the decision had been made for four reasons. Restaurants and associated business account for 90% of Cara's sales and are concentrated in the value/quick service segment, making Cara more resilient to economic cycles.

Dominion Bond Rating Service Ltd (DBRS) has confirmed the senior debt and commercial paper ratings of Canadian foodservice giant Cara Operations at BBB and R-2 (high), respectively, with stable trends.

DBRS explained that the decision had been made for four reasons. Restaurants and associated business account for 90% of Cara’s sales and are concentrated in the value/quick service segment, making Cara more resilient to economic cycles.

Secondly, Cara has a reasonable balance sheet. Although the acquisition of the remaining 61% of the Second Cup that Cara did not own has increased debt by around C$50m, pro forma liquidity and coverage ratios remain adequate. The proposed acquisition of Milestone’s (C$15m cash) is more than offset by the C$30m sale of the Health Services business.

Thirdly, profit margin has improved with the sale of low margin Beaver Foods in December 2000, as EBITDA margin has risen above 10%. The sale of the Health Services business confirms Cara’s strategy to focus on high margin businesses.

Fourthly. the acquisition of Second Cup will be modestly accretive to earnings (2001 EBIT- C$7m) in 2003. The acquisition is viewed positively, as it offers the company an avenue for future growth. The Milestone’s acquisition is expected to strengthen Cara’s restaurant portfolio in western Canada and should provide growth opportunities in eastern Canada.

Lastly, Cara has promising expansion plans as it will spend a reasonable C$50m-$60m to rollout 55-60 new restaurants and Second Cup locations each year.

DBRD admits however that despite its strengths, Cara faces four considerable challenges. Although Cara operates Canada’s leading airline catering business and faces hardly any domestic competition, substantial reduction in on-flight food offerings by the airlines will restrict growth. However, with the addition of the new contract of Canadian Airlines business and increasing airline traffic due to the strengthening economy, the airline business should grow in 2003.

Secondly, competitors in the quick service segment are generally larger and more focused. These competitors are global and run aggressive consumer promotions to attract customers. McDonald’s plans to add around 900 outlets in the next three years in Canada.

Thirdly, Cara operates seven relatively small independent restaurant chains. Although economies of scale are available in many operating areas such as purchasing, systems, real estate and distribution, individually each restaurant chain cannot sustain large promotional and advertising spending.

Lastly, although comparable sales for the first nine months of 2002 grew by 16%, EBIT declined by 5%, primarily due to weakness at the airport services business. The net profit margin improved marginally due to lower interest cost, yet it is weak at about 3.8% versus in excess of 4.4% prior to 1998.

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