Fitch Affirms Safeway's IDR at 'BBB-'; Outlook Revised to Negative
Fitch Ratings has affirmed Safeway Inc.'s (Safeway) Long-Term Issuer Default Rating (IDR) at 'BBB-', and Short-Term IDR at 'F3'. The Rating Outlook has been revised to Negative from Stable. As of Sept. 8, 2012, Safeway had $6.4 billion of debt outstanding, including capital leases. A full rating list is shown below.
The affirmation reflects Safeway's position as the number two traditional supermarket chain in the U.S., its updated store base as a result of an extensive remodeling program, and healthy free cash flow.
The Negative Outlook reflects Safeway's weak traction on identical store sales and soft operating trends, as Safeway and other traditional supermarkets have ceded market share to discounters and other alternative formats over the past few years. The Outlook also considers Safeway's relatively high financial leverage due to leveraged share repurchase activity over the past year, and Fitch's expectation that it may remain above its historical year-end level of around 3.0x beyond 2013.
Safeway has experienced soft sales trends over the past two years, including a 0.3% increase in nonfuel ID sales in the first three quarters of 2012, following a 1% increase in 2011, as the effect of price inflation has been offset by lower volumes. This follows ID sales declines in 2009 - 2010, when the company made significant price investments to improve its competitiveness.
Fitch anticipates Safeway's ID sales will remain weak relative to market-leader Kroger over the intermediate term, given that Kroger has denser market shares in many of its key markets and has strong consumer price perception. While Safeway has seen some stabilization in its market share over the past two quarters, and the 'Just for U' digital marketing effort and food price inflation should support some traction to its business in the near term, Fitch remains concerned about the company's overall competitive positioning. Fitch believes nonfuel ID sales will trend towards 1%-2% over the next 12 months, and that it is too early to ascertain whether its new fuel loyalty program or yet-to-be announced wellness initiative will drive ID sales above 2%.
Safeway's EBIT margin has been in decline over the past four years, and stood at 2.5% in the 12 months ended June 16, 2012, compared with 2.7% in 2011 and 3.0% in 2010. Weaker margins reflect the impact of price investments and the mix effect of higher gasoline prices, among other things.
Going forward, EBIT margins could come under additional pressure as growing competition may necessitate additional price investments, while relatively slow ID sales growth would make it difficult to leverage the company's significant fixed costs.
Safeway launched an accelerated debt-financed share repurchase program in the fourth quarter of 2011, causing adjusted debt/EBITDAR to increase to 3.8x at Sept. 6, 2012, from 3.3x at year-end 2011. Higher borrowings at the end of the third quarter also reflect the seasonal nature of cash flow from the Blackhawk business, which has significant cash outflows in the first quarter and significant cash inflows in the fourth quarter.
This accelerated share repurchase program is a temporary departure from its historical financial strategy, and the goal is to return leverage to its historical level of around 3.0x by the end of 2013 both on improving EBITDA and debt reduction. However, given the current softness in the business and Fitch's expectation that trends will remain weak, Fitch believes the targeted leverage goal will be challenging to attain in 2013 and potentially even longer term.
Fitch expects Safeway to generate annual FCF (after dividends and before property sales) of $400 million - $600 million annually over 2012 - 2014. Fitch anticipates leverage will improve to around 3.5x at year-end 2012, which is modestly higher than its prior expectations and move to the 3.3x range in 2013 based on $800 million of expected debt reduction.
What Could Trigger a Rating Action
Safeway's rating is positioned at the low end of the 'BBB-' level, leaving limited cushion in the rating for continued operating weakness.
For Fitch to move to a Stable Outlook, it would need to see:
--Positive same store sales traction in the fourth quarter and ID sales at or above 2% in 2013 and beyond.
--Stabilization in operating EBIT margin in the mid 2% range.
A downgrade could be caused by the following factors, individually or collectively:
--Sales do not gain meaningful traction.
--Operating margins continue to move lower, to the low 2% range, constraining cash flow.
--Adjusted leverage remains above 3.1-3.3x.
Fitch affirms Safeway's ratings as follows:
--Long-term IDR at 'BBB-';
--Senior unsecured notes at 'BBB-';
--$1.5 billion bank credit facilities at 'BBB-';
--Short-term IDR at 'F3';
--Commercial paper at 'F3'.
The Rating Outlook has been revised to Negative from Stable.
Additional information is available at 'www.fitchratings.com.' The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Short-Term Ratings Criteria for Non-Financial Corporates' (Aug. 9, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Short-Term Ratings Criteria for Non-Financial Corporates
Philip Zahn, CFA
70 West Madison Street
Chicago, IL 60602
Monica Aggarwal, CFA