Fitch Affirms Kroger's IDR at 'BBB'; Outlook Stable
Fitch Ratings has affirmed The Kroger Co.'s (Kroger) long-term Issuer Default Rating (IDR) at 'BBB', and its short-term IDR and commercial paper rating 'F2'. The Rating Outlook is Stable. As of Aug. 11, 2012, Kroger had $8.1 billion of debt outstanding, including capital leases. A full list of rating actions is shown below.
The affirmation reflects Kroger's industry leading sales growth and market share gains, strong cash flow, and steady credit metrics. The IDR also considers the company's moderate financial leverage, ongoing share repurchase activity, and intense price competition that will continue to pressure gross margins.
Kroger generates industry leading non-fuel identical store (ID) sales as a result of strong pricing perception by customers, effective marketing through use of loyalty card data, and improvements to the shopping experience. ID sales growth of 3.9% in the first half of 2012, follows increases of 4.9% in 2011 and 2.8% in 2010, leading to market share gains in most of its major markets. The company has achieved these results despite the weak consumer environment and intense competition from discount and specialty formats.
Kroger's EBIT margin declined to 2.5% in the latest 12 months (LTM) ended Aug. 11, 2012 from 2.8% in 2010 and 3% in 2009, due to ongoing price investments and an increase in lower margin fuel sales. The EBIT margin on a FIFO basis excluding fuel was up slightly in 2011, and is expected to be flat to slightly improved going forward. Longer term, Fitch expects only a modest recovery of EBIT margins from current levels, given continuing gross margin pressure due to price investments offset by expense leverage.
Fitch views Kroger's new growth strategy calling for 8%-11% annual growth in earnings per share compared with a previous 6%-8% target as neutral from a credit perspective, given that Fitch doesn't expect any changes to Kroger's financial policies. The new strategy calls for a $200 million increase in capex beginning in 2013, with the additional investment directed to store growth in existing and new markets. Fitch expects Kroger will focus on in-market acquisitions of small groups of stores, as well as selected entries into new markets.
Kroger's financial leverage (lease-adjusted debt/EBITDAR) has been steady at around 3.0 times (x) over the past four years. FCF after dividends is expected to track around $400 million - $600 million annually over the next three years, taking into account a $200 million increase in capital expenditures beginning in 2013, per the company's new growth strategy.
Management is expected to direct essentially all of this cash flow and potentially some incremental borrowing to share repurchases and dividends, in order to manage lease-adjusted debt/EBITDAR at or close to 3.0x (which roughly equates to the company's net debt/EBITDA target of 2.0x). Future debt maturities, including $500 million of senior notes due in February 2013 and $400 million due in April 2013, are expected to be refinanced.
This leverage target is considered consistent with the 'BBB' rating. However, in light of the challenges facing the supermarket industry, including competitive pressures from discount formats and the meaningful margin compression that occurred in 2009-2010, it doesn't afford as much cushion within the rating level for leveraging actions or operating shortfalls, as it did pre-2009.
What Could Trigger A Rating Action
Positive Drivers: Ongoing solid sales growth and a meaningful margin recovery together with a more conservative financial profile could lead to a positive rating action. However, this is not anticipated at this time.
Negative Drivers: Continued pressure on margins and/or a more aggressive approach to share repurchases that pushes leverage higher could lead to a negative rating action.
Fitch has affirmed the following ratings:
The Kroger Co.
--Long-term IDR at 'BBB';
--Senior unsecured notes at 'BBB';
--Bank credit facility at 'BBB';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
The Rating Outlook is Stable.
In accordance with Fitch's policies, the issuer appealed and provided additional information to Fitch that resulted in a rating action which is different than the original rating committee outcome.
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, +1-312-606-2336
70 West Madison Street
Chicago, IL 60602
Monica Aggarwal, CFA, +1-212-908-0282
Michael Simonton, +1-312-368-3138
Brian Bertsch, +1-212-908-0549