Fitch Rates Kroger's Proposed 10- and 30-Year Notes 'BBB'
CHICAGO -- July 18, 2013
Fitch Ratings has assigned a rating of 'BBB' to The Kroger Co.'s (Kroger)
proposed issue of 10- and 30-year senior unsecured notes. The Rating Outlook
is Stable. As of May 25, 2013, Kroger had $7.9 billion of debt outstanding,
including capital leases. A full list of rating actions is shown below.
KEY RATING DRIVERS
Kroger's ratings are supported by its industry-leading sales growth and market
share gains balanced against ongoing share repurchase activity and intense
price competition that will continue to pressure gross margins.
The ratings also take into account Kroger's announcement that it has entered
into a definitive merger agreement with Harris Teeter Supermarkets, Inc.
(HTSI), a regional supermarket chain located in the southeast U.S. Kroger has
agreed to acquire HTSI for $2.5 billion (7.3x EBITDA), and plans to finance
the acquisition with debt.
Fitch views the addition of HTSI as neutral-to-moderately positive from a
business perspective, and believes that the risks associated with integrating
HTSI into Kroger's network are manageable. In addition, financial leverage,
after initially increasing to a pro forma 3.3x on an adjusted debt/EBITDAR
basis, is expected to recover to near 3.0x within 18-24 months after the close
of the acquisition.
In light of the challenges facing the supermarket industry, including
competitive pressures from discount formats and the margin compression that
has occurred since 2009, adjusted leverage of around 3x would be at the high
end of the rating level, and does not provide much cushion for additional
leveraging actions or operating shortfalls.
Steady Operating Results
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 3.3% in the first quarter of 2013 (1Q'13) follows increases of
3.5% in 2012 and 4.9% in 2011, 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
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 on a FIFO basis excluding fuel and the effect of the extra week
(in 2012) was up slightly in each of 2011 and 2012, and is expected to be flat
to slightly improved going forward.
Free cash flow (FCF) after dividends is expected to track around $300 million
annually going forward, below the $500 million achieved in 2011-2012, due to
an increase in capex, driven by management's desire to accelerate its store
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.
A negative rating action would be considered if adjusted leverage does not
improve to a level near 3x within 18 to 24 months after the close of the
transaction, 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', Aug. 8, 2012;
--'Short-Term Ratings Criteria for Non-Financial Corporates', Aug. 9, 2012.
Applicable Criteria and Related Research:
Short-Term Ratings Criteria for Non-Financial Corporates
Corporate Rating Methodology
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Philip Zahn, CFA
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
Monica Aggarwal, CFA
Brian Bertsch, New York, +1 212-908-0549
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