Fitch Ratings has assigned a rating of 'BBB' to The Kroger Co.'s (Kroger) $450 million issue of 2.2% notes due 2017, the proceeds of which will be used to fund a contribution to a newly consolidated multi-employer pension fund. The Rating Outlook is Stable. A full list of ratings is shown below.
The rating reflects Kroger's industry-leading sales growth and market share gains, strong cash flow, and relatively steady credit metrics. The rating also considers 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 identical store (ID) 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 4.9% in the first three quarters of 2011 (ending Nov. 5, 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 latest 12 months (LTM) ended Nov. 5, 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) was steady at 2.9 times (x) at Nov. 5, 2011 compared with 3.0x at end-2010. 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 $1.3 billion of its shares in the first three quarters of 2011 compared with $292 million in the first three quarters 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 much cushion within the rating level for leveraging actions or operating shortfalls.
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 796 convenience and 361 jewelry stores. As of Nov. 5, 2011, 1,067 of its large stores and most of its convenience stores had fuel centers.
Fitch currently rates Kroger as follows, with a Stable Outlook:
--Long-term IDR 'BBB';
--Senior unsecured notes 'BBB';
--Bank credit facility 'BBB';
--Short-term IDR 'F2';
--Commercial paper '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.
--'Analysis of U.S. Corporate Pensions', Aug. 5, 2011.
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229
Short-Term Ratings Criteria for Non-Financial Corporate
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647249
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.
Contacts:
Fitch Ratings
Primary Analyst
Philip Zahn, CFA, +1-312-606-2336
Senior
Director
Fitch, Inc.
70 West Madison Street
Chicago, IL
60602
or
Secondary Analyst
Monica Aggarwal, CFA,
+1-212-908-0282
Senior Director
or
Committee Chairperson
Robert
Curran, +1-212-908-0515
Managing Director
or
Media
Relations:
Brian Bertsch, +1-212-908-0549
Email: brian.bertsch@fitchratings.com
