Fitch Ratings places Safeway's ratings on Rating Watch Negative following announcement that company is in discussions concerning possible sale, in anticipation that sale could cause financial leverage to increase further
February 24, 2014
– Fitch Ratings has placed Safeway Inc.'s (Safeway) ratings on Rating Watch Negative. Fitch currently rates Safeway's Long-Term Issuer Default Rating (IDR) 'BBB-', and its Short-Term IDR 'F3'. As of Dec. 28, 2013, Safeway had $4.2 billion of debt outstanding, including capital leases. A full rating list is shown below.
Key Rating Drivers:
The Rating Watch Negative follows Safeway's announcement that it is in discussions concerning a possible sale of the company and reflects the expectation that a sale of the company could cause financial leverage to increase further, into the mid-4x range or higher depending on the structure of the transaction.
Safeway also announced that it intends to distribute its 72.2% stake in Blackhawk (which generated $114 million in EBITDA in 2013) to Safeway shareholders, and that it is exploring the monetization of its 49% holding in Casa Ley, the fifth-largest food and general merchandise retailer in Mexico. Fitch views a spin-off of the Blackhawk business as a modest negative to the company's credit profile, given Blackhawk's contribution to Safeway's cash flow and its healthy growth potential. The credit implications of a sale of Casa Ley will depend on how Safeway deploys the proceeds.
Safeway reported soft operating results for 2013, with identical store (ID) sales growth (excluding fuel) remaining sluggish at 1.7%, although this is an improvement from the 0.8% posted in 2012. The company's market share has been relatively stable for the past few quarters. The gross margin ex-fuel contracted by 15 basis points (bps) due to price investments and higher inventory shrink. Fitch expects ID sales growth will likely be at or under 2% in 2014, with the potential for additional gross margin pressure.
The sale of the profitable Canadian business in 2013, together with competitive pressures on the remaining domestic business, led to a reduction in the operating EBIT margin to 1.9% in 2013 from 2.6% in 2012. Fitch expects that operating margins could be modestly lower, as the company may need to make incremental investments to accelerate its top-line growth. Fitch believes it will be difficult for Safeway to restore its EBIT margin to its pre-Canada sale level of 2.5% given that gross margins continue to contract across the sector, and that Safeway's sales growth is insufficient to meaningfully leverage its fixed operating expenses.
Safeway's lease-adjusted financial leverage was 3.6x as of end-2013. In the event the company is not sold, leverage would be expected to move to a level close to 3.0x, taking into account the spin-off of the Blackhawk business and the completion of an additional $1.5 billion of previously planned debt reduction. Fitch notes that Safeway also has sizable pension liabilities that are not included in these leverage calculations, but nonetheless represent a significant obligation.
Future developments that may, individually or collectively, lead to a negative rating action include:
The company is sold in a leveraging transaction, ID sales growth stalls causing operating margins to contract further, and adjusted leverage moves above the low 3x range.
Future developments that may, individually or collectively, lead to a Stable Outlook include:
Consistent ID sales growth of 2% or above, a stable to improving EBIT margin, and a consistent financial policy with adjusted leverage being maintained below 3x.
Fitch places Safeway's ratings on Rating Negative Watch as follows:
--Long-term IDR 'BBB-';
--Senior unsecured notes 'BBB-';
--$1.5 billion bank credit facilities 'BBB-';
--Short-term IDR 'F3';
--Commercial paper 'F3'.
Additional information is available at 'www.fitchratings.com.'
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Short-Term Ratings Criteria for Non-Financial Corporates' (Aug. 5, 2013).
In accordance with Fitch's policies the issuer appealed and provided additional information to Fitch that resulted in a rating action that is different than the original rating committee outcome.
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Short-Term Ratings Criteria for Non-Financial Corporates
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