Fitch affirms Kroger's Long-term Issuer Default Rating at BBB, Short-term IDR and commercial paper rating at F2, with stable outlook, reflecting company's industry-leading sales growth, market share gains in face of intense price competition

Cindy Allen

NEW YORK , July 7, 2014 (press release) – Fitch Ratings has affirmed The Kroger Co.'s (Kroger) Long-term Issuer Default Rating (IDR) at 'BBB', and Short-term IDR and commercial paper rating at 'F2'. The Rating Outlook is Stable.

KEY RATING DRIVERS

Kroger's ratings are supported by its industry-leading sales growth and market share gains and relatively stable operating margins balanced against ongoing share repurchase activity and intense price competition.

Kroger generates industry-leading non-fuel identical store (ID) sales growth 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 4.6% in the first quarter of 2014 follows increases of 3.5% in 2013 and 3.5% in 2012, 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. Fitch expects Kroger will maintain low to mid-single digit ID sales growth over the next 2-3 years.

Kroger has gradually managed down its gross margin ratio, and has offset this pressure with cost containment efforts and the leveraging of fixed costs. The EBIT margin was up slightly in 2012 and 2013, to 2.9% in the twelve months ended May 24, 2014, and is expected to be flat-to-slightly improved going forward.

Free cash flow (FCF) after dividends is expected to track around $500 million - $600 million annually over the next three years, taking into account growth in capital expenditures to the $2.8 billion - $3.0 billion range in 2013 (year ended Jan. 2014), and increasing by $200 million/year in subsequent years. Share repurchases continue to be managed at a level that permits consistent financial leverage.

The ratings take into account Kroger's merger with Harris Teeter Supermarkets, Inc. (HTSI) in January 2014 for $2.4 billion (7.3x EBITDA), which was financed with debt. Fitch views the addition of HTSI as neutral to moderately positive from a business perspective, and that the risks associated with integrating HTSI into Kroger's network are manageable.

Adjusted debt/EBITDAR increased from 2.6x prior to the acquisition (at Nov. 9, 2013), to a pro forma 3.1x at fiscal yearend (2/1/14), which is close to the company's targeted range (net debt/EBITDA of 2.0x - 2.2x, which equates to adjusted debt/EBITDAR of 3.0x - 3.2x).

Debt levels are expected to be steady in 2014 as the company manages leverage down to its targeted range. Beyond 2014, management is expected to direct essentially all of its free cash flow and potentially some incremental borrowing to share repurchases in order to maintain adj. leverage at around 3.0x.

RATING SENSITIVITIES

A positive rating action would be considered if adjusted leverage improved to the mid-2x range, together with steady mid-single-digit ID sales growth and gradual margin improvement. This is not anticipated at this time.

A negative action would be considered if adjusted leverage moved up to the low 3x range due to pressure on margins and/or a more aggressive approach to share repurchases or acquisitions.

Fitch has affirmed Kroger's ratings as follows:

--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.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology'( May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=837934

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Contacts

Fitch Ratings
Primary Analyst
Philip Zahn, CFA
Senior Director
+1-312-606-2336
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
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Monica Aggarwal, CFA
Senior Director
+1-212-908-0282
or
Committee Chairperson
Sean Sexton
Managing Director
+1-312-368-3130
or
Media Relations
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com

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