Fitch Ratings affirms Kroger's Issuer Default Rating at BBB with stable outlook, reflecting company's sales growth, market share gains, strong cash flow
November 8, 2011
– Fitch Ratings has affirmed its ratings on The Kroger Co. (Kroger), including the Issuer Default Rating (IDR) at 'BBB'. The Rating Outlook is Stable. As of Aug. 13, 2011, Kroger had about $7.3 billion of debt outstanding, including capital leases. A full list of rating actions is shown below.
The ratings reflect Kroger's industry leading sales growth and market share gains, strong cash flow, and relatively steady credit metrics. The ratings also consider the company's recently more aggressive share repurchase activity, and intense price competition in the sector that will continue to pressure gross margins.
Kroger generates industry leading non-fuel ID store sales as a result of strong pricing perceptions by customers, effective marketing through use of loyalty card data, and improvements to the shopping experience. ID sales growth of 4.6% in the first quarter of 2011 (Q1'11) and 5.3% in Q2'11 (ending Aug. 13, 2011), follows increases of 2.8% in 2010 and 2.1% in 2009, leading to market share gains in most of its major markets. The company has achieved these results despite intense competition in the industry, consumers trading down to lower priced or promotional products, and food deflation during the period prior to 2011.
Kroger's profitability has been pressured by the investments it has made in its prices, offset in part by ongoing cost containment efforts. The EBIT margin declined to 2.7% in the LTM ended Aug. 13, 2011, from 2.9% in 2010, due in part to an increase in lower margin fuel sales.
EBIT margins over the last couple of years are down 50 basis points from the 3.3% - 3.4% achieved during 2005-2008. However, the EBIT margin excluding fuel is expected to stabilize in 2011 as the company passes through higher food costs in its prices and controls its expenses. Longer-term, Fitch expects only a modest recovery of EBIT margins from current levels, given continuing gross margin pressure offset by cost containment efforts.
Kroger's financial leverage (lease-adjusted debt/EBITDAR) improved to 2.8 times (x) at Aug. 13, 2011 from 3.0x at end-2010, reflecting the repayment of $478 million of maturing debt and modestly higher EBITDAR. However, Kroger has been more aggressive in repurchasing shares in 2011, which will likely push leverage back toward 3.0x over the near term.
Kroger repurchased $803 million of its shares in the first half compared with $228 million in the first half of 2010. In addition, the company announced a new $1 billion share repurchase authorization in September 2011, which will be utilized over the next 12 months.
Free cash flow (FCF) after dividends is expected to track around $600 million - $800 million over the next three years, helped by moderate growth in EBITDA and steady capital expenditures. 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 $850 million coming due in 2012, 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.
Kroger benefits from the geographic breadth and diverse formats of its store base with 2,439 supermarket and multi-department stores across 31 states, as well as 788 convenience and 361 jewelry stores. As of Aug. 13, 2011, 1,046 of its large stores and most of its convenience stores had fuel centers.
Fitch has affirmed Kroger's ratings as follows with a Stable Outlook:
--Long-term IDR at 'BBB';
--Senior unsecured notes at 'BBB';
--Bank credit facility at 'BBB';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
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. 12, 2011;
--'Short-Term Ratings Criteria for Non-Financial Corporates', Aug. 12, 2011.
Applicable Criteria and Related Research:
Corporate Rating Methodology
Short-Term Ratings Criteria for Non-Financial Corporate