July 19 (Bloomberg) -- The cost to protect the debt of Safeway Inc. rose to a record after the second-largest U.S. grocer reported a 17 percent drop in second-quarter profit from continuing operations.
Credit-default swaps tied to Safeway jumped 10.3 basis points to a mid-price of 475 basis points at 3:30 p.m. in New York, according to data compiled by Bloomberg, the highest level in figures dating back to July 2002.
Safeway said net income from continuing operations plunged to $121.7 million, or 50 cents a share, from $146 million, or 41 cents, in the year-earlier period. Analysts had called for earnings of 49 cents a share for the Pleasanton, California-based company, according to Bloomberg data.
“They’re in the same boat as the other grocers in that it’s a challenging environment,” Michael Kraft, senior portfolio manager at Vanderbilt Avenue Asset Management LLC, said of Safeway in a telephone interview. “You’ve got increasing costs, some margins are down, profits are down and it’s just an increasingly competitive environment.”
Same-store sales increased 1.8 percent in the second quarter, edging up from a gain of 1.6 percent in the first quarter that was the slowest pace since 2010, Bloomberg data show. Sales growth excluding fuel was 0.8 percent in the period ended June 30, according to a statement from the company.
“We’re very comfortable with the position that we’re in,” Melissa Plaisance, Safeway senior vice president of investor relations, said in a telephone interview. “I believe the credit-default swaps market is one that is not based on actual investor fears, but rather, run by speculative investors. We’re very much on top of our plan and things have gone according to the plan that we laid out for the ratings agencies.”
Safeway boosted its leverage to a seven-year high after selling $800 million of bonds in November and arranging a $700 million term loan to help fund share repurchases and payments on $800 million of debt maturing Aug. 15.
Creditors were “disappointed” by the debt-financed share buyback, which they may perceive as a risk to push the company’s ratings below investment-grade, Noel Hebert, chief investment officer at Bethlehem, Pennsylvania-based Concannon Wealth Management LLC, which oversees about $250 million, wrote in an e-mail.
The grocery chain’s ratio of debt to trailing 12-month earnings before income, taxes, depreciation and amortization was 2.96 in the first quarter, the highest level since 2005 and more than the 1.90 average for peers with market values bigger than $100 million, according to data compiled by Bloomberg.
Moody’s Investors Service rates Safeway Baa3, the lowest investment-grade ranking, and Standard & Poor’s grades the grocer one level higher at BBB.
Safeway’s competitor Supervalu Inc., the third-largest U.S. grocery-store chain, announced a strategic review of its business and suspended its dividend on July 11 as competition from Wal-Mart Stores Inc. and Kroger Co. pressures revenue.
Contracts tied to Supervalu declined 1.7 percentage points to 26.2 percent upfront, down from 27.9 percent upfront yesterday, 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 $2.62 million initially and $500,000 annually to protect $10 million of Supervalu’s debt.
Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. The contracts typically rise as investor confidence deteriorates and fall as it improves. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
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