Supervalu Inc. (SVU)’s plans to reverse a 35 percent drop in its stock this year has cost bondholders $471 million as they deem the debt of the third-largest U.S. grocer to be in distress.
The bonds are the worst performers among the 50 biggest issuers in the Bank of America Merrill Lynch B rated index this month, with the extra yield investors demand to hold the debt instead of Treasuries widening 4.55 percentage points to 11.87 percentage points, more than the 10 percentage-point gap indicating distress. The index spread narrowed 6 basis points to 6.32 percentage points.
Investors are concerned that a new credit agreement Supervalu reached for its loans that doesn’t have financial maintenance restrictions will encourage the Eden Prairie, Minnesota-based operator of the Shaw’s and Save-A-Lot chains to increase leverage as it seeks to boost profitability. The company announced last week that its first-quarter net income fell 45 percent and that it would cut prices to increase sales.
“Credit metrics will get worse in the near term,” Edward Mui, an analyst at CreditSights Inc. in New York, said in a telephone interview. “Now that the company is no longer constrained by financial covenants they can pursue a more dramatic policy in their operating strategy."
Supervalu is arranging $2.5 billion in loans that allow the company to get rid of covenants in its prior credit agreement that restricted the amount of debt it can have relative to earnings before interest, taxes, depreciation and amortization.
At the same time, the grocery chain plans to accelerate price reductions and cut costs by an additional $250 million over the next two years as part of its strategic review, according to a July 11 statement.
“It’s a risky maneuver because usually when you mark down prices competition will follow,” Mui said.
Michael Siemienas, a spokesman for Supervalu, declined to comment beyond what was included in the statement.
Supervalu’s $1 billion of 8 percent notes due May 2016 fell 16.4 cents in the two days ended July 13 to 85.13 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The yield rose to 13.1 percent, the highest since the debt was issued in 2009.
The value of all the grocer’s bonds fell to $2.64 billion from $3.11 billion on July 10, the day before the statement was released, the index shows. Loomis Sayles & Co. is one of the largest investors in Supervalu’s notes, holding 6.3 percent of the debt, according to data compiled by Bloomberg.
Supervalu’s bank group -- Credit Suisse Group AG, Barclays Plc, Wells Fargo & Co. and U.S. Bancorp -- met with lenders July 13 to discuss details of the new loan, according to a person with knowledge of the transaction, who asked not to be identified because the terms are private. The underwriters are proposing to offer the $850 million, covenant-lite portion of the credit facility to lenders at the higher of 7.5 percent or 6.25 percentage points more than the London interbank offered rate. Libor, a lending benchmark, was fixed at 0.46 percent on July 13.
Supervalu was required to maintain a leverage ratio no greater than 3.75 times under its previous credit agreement, according to an April 19 annual earnings report filed with the U.S. Securities and Exchange Commission. That ratio was 3.47 times as of February 25, and may increase to 3.8 times at the end of Supervalu’s fiscal year, a breach of the old covenant, according to a July 12 CreditSights report.
Fitch Ratings cut its rating on Supervalu July 12 to CCC, indicating “high default risk,” from B, with the report citing deteriorating operating results and the potential for higher financial leverage if the company is sold.
“The challenge is how quickly traffic will respond to lower prices,” Philip Zahn, an analyst at Fitch, said in a telephone interview. “It will take some time and exactly how consumers respond is difficult to predict.”
Goldman Sachs Group Inc. and Greenhill & Co. are helping Supervalu evaluate strategic alternatives, according to the company statement.
Credit-default swaps tied to Supervalu jumped 2.6 percentage points to 29.3 percent upfront, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. That’s in addition to 5 percent annually, meaning it would cost $2.93 million initially and $500,000 a year to protect $10 million of Supervalu’s debt.
The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Net income in the company’s fiscal first quarter fell 45 percent to $41 million, or 19 cents a share, from $74 million, or 35 cents, a year earlier, the company said in the statement. Sales declined 4.7 percent to $10.6 billion, trailing the $10.8 billion average of analysts compiled by Bloomberg.
Supervalu’s stock lost value after the new strategy, which included suspending the 8.75 cent quarterly dividend, was announced. The shares, which closed before the July 11 announcement, fell 56 percent the following two days to $2.32 each. They rose 5 cents, to $2.37, at 11:38 a.m. in New York today. That brought the cumulative year-to-date loss to 70.8 percent, Bloomberg data show.
The new term loan will be secured by real estate assets, according to Fitch’s Zahn, effectively subordinating the unsecured bondholders. The grocer’s $490 million of 7.5 percent senior unsecured bonds due November 2014 fell 0.8 cent to 89.2 cents on the dollar today, the lowest level since they reached 83 cents on Dec. 22, 2008, Trace data show.
“With the company’s new credit agreement carrying no financial covenants, Supervalu’s priority of protecting profits and credit metrics will be diffused,” Mui at CreditSights wrote in a July 12 report. “Accordingly, we expect deteriorating credit metrics and strategic uncertainty to weigh on current trading levels.”
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