CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed its 'B' Issuer Default Rating (IDR) on SUPERVALU Inc. (SVU), post the company's announcement that it is exploring the potential separation of its Save-A-Lot business through a spin-off of the business into a stand-alone, publicly traded company. The Rating Outlook is Stable. A complete list of ratings is provided at the end of this release.
KEY RATING DRIVERS
SVU has reported improved operating results over the past two years as it has cut expenses, decentralized its supermarket operations and invested in price reductions to revive sales growth. The affirmation takes into account these improving trends as well as the company's positive free cash flow (FCF) and moderately high financial leverage in the low 4x range. Should Save-A-Lot not be spun off and continue its strong trajectory, SVU's operating and financial profile could support a high 'B' rating.
However, a spin-off of Save-A-Lot would negatively impact SVU's business profile by removing SVU's primary growth vehicle, which generated $221 million of EBITDA in fiscal 2015 (27% of consolidated EBITDA) and has significant long-term growth upside. SVU's remaining businesses are the mature Retail Food (supermarket) and Independent Business (wholesale grocery) segments.
These businesses generate healthy cash flow but could see modest EBITDA pressure over time. SVU's EBITDA pro forma for a spin-off of Save-A-Lot was $586 million in fiscal 2015. Fitch assumes that pro forma EBITDA could drift lower over the next two years to the $550 million-$560 million range due to soft sales and gradual margin compression in both segments.
SVU's adjusted debt/EBITDAR was 4.0x at June 20, 2015, and Fitch estimates it would be around 5x pro forma for a Save-A-Lot spin-off assuming no debt is repaid. If Save-A-Lot incurs some debt in conjunction with a spin-off and upstreams the proceeds to SVU, and SVU uses the proceeds to pay down its debt, SVU's adjusted financial leverage could range from 4x-5x post-spin, assuming debt paydown that ranges from $100 million to $750 million.
Should SVU choose to sell Save-A-Lot, and broadly assuming an EBITDA multiple of 8x-10x, the gross proceeds could range from $1.8 billion- $2.2 billion. In either a spin-off or sale, if debt paydown is more significant and exceeds $750 million and adjusted leverage is at or under 4x, there could be upside to the 'B' rating.
The term loan requires the first $750 million of proceeds from a sale of Save-A-Lot be used to pay down the term loan, as well as 50% of the proceeds in excess of $750 million up to the amount that would cause the total secured leverage ratio to be 1.5x. Fitch believes the company would have to obtain an amendment to the term loan to proceed with a spin-off.
Business Trends Without a Save-A-Lot Spin-off
Save-A-Lot had healthy 5.8% identical store (ID) sales growth in fiscal 2015, while ID sales in the retail food segment turned positive (up 1%). Sales in the independent business were lower for the year -- excluding the effect of the 53rd week. Consolidated EBITDA increased to $826 million in 12 months ended June 20, 2015 from $807 million in fiscal 2015, excluding restructuring charges, due to gross margin expansion and a reduction in losses at the corporate segment.
On a status quo basis, Fitch expects EBITDA to be relatively stable in the low-$800 million range over the next two years, but there could be some longer term pressure on EBITDA from the wind-down of the transition services agreement (TSA) with the Albertsons entities.
Management has indicated it has plans in place to mitigate the loss of two-thirds of the fiscal 2015 TSA revenues ($125 million) through cost reductions and additional services revenue streams. One such revenue stream will be from a new TSA entered into with Haggen, Inc. (Haggen), under which SVU will provide certain back-office services to Haggen's 164 stores. SVU will have to develop additional cost reductions or revenue sources to mitigate the remaining one-third, or around $65 million.
This implies there is a $65 million downside to EBITDA if SVU is unable to mitigate these costs. A $65 million reduction in EBITDA would push adjusted leverage back up to around 4.3x from 4.0x currently, and SVU would still be FCF positive at around $50 million-$100 million annually at this level.
In view of its improved ID sales growth, management is accelerating Save-A-Lot's store expansion, with plans to build 100 new stores per year in fiscals 2016-2017, increasing to 150 new stores in fiscal 2018. Net of store closings, this would equate to 5%-7% annual square footage growth and will drive capex up to $300 million-$320 million in fiscal 2016 from $239 million in fiscal 2015. Fitch estimates this will constrain FCF to $100 million-$150 million annually, compared with $169 million in fiscal 2015.
Higher EBITDA and modest debt repayment led to a reduction in adjusted debt/EBITDAR to 4.0x at June 20, 2015 from 4.1x at the end of fiscal 2015 and 4.3x at the end of fiscal 2014. On a status quo basis, Fitch expects FCF will be used in part for debt reduction, but that off-balance sheet debt (8x rents) will grow as a result of the store expansion at Save-A-Lot, leading to steady adjusted leverage in the low 4.0x range.
RECOVERY ANALYSIS
Fitch's ratings on individual debt issues are based on the IDR and the expected recovery in a distressed scenario. Fitch has allocated a distressed enterprise value of $2.7 billion (after administrative claims, and assuming Save-A-Lot is not spun off) across the capital structure. Fitch arrives at this valuation by multiplying an assumed post-default EBITDA of approximately $610 million by a 4.9x multiple. The post-default EBITDA assumes a 33% decline in EBITDA at retail food and the independent business, and flat EBITDA at Save-A-Lot. The blended multiple is based on 4.0x for the retail food segment, 4.5x for the independent business and 6.5x for Save-A-Lot.
The $1 billion revolving ABL facility, which is assumed to be 70% drawn, is backed by inventories, receivables and prescription files, which Fitch collectively values at $1.2 billion. The $1.5 billion term loan is backed by real estate with a book value of $776 million and an estimated market value of $1 billion, and a pledge of the shares of Moran Foods, LLC (Save-A-Lot), which Fitch values at $1.4 billion, assuming a 6.5x multiple of EBITDA (net of allocated corporate expenses). As such, both facilities are assumed to receive a full recovery, leading to a rating on both facilities of 'BB/RR1'.
The senior unsecured notes are rated 'B/RR4', implying a 30%-50% recovery in a going concern scenario. Fitch believes in a liquidation scenario, SVU's company pension plan's underfunding of $532 million and MEPP's underfunding of $447 million would rank ahead of the senior unsecured notes given the unique structural priorities available to the PBGC and pension plan fiduciaries. Therefore, in a liquidation scenario, there would be no recovery to the senior notes.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for SUPERVALU include:
--The rating case assumes that it is probable that the company separates the Save-A-Lot business.
--Annual revenue growth of 0% to 1%, excluding Save-A-Lot.
--EBITDA trends towards $550 million-$560 million over the next 24 months, versus a pro forma $586 million in fiscal 2015.
--The company remains FCF positive.
--Leverage is in the low 4x to 5x range.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a positive rating action include more robust top-line growth and steady to improving EBITDA, steady results in the Independent Business and Retail food segments, effective management of the TSA wind down, and adjusted debt/EBITDAR that is at or below 4x.
Future developments that may, individually or collectively, lead to a negative rating action include more negative operating trends across the business, with top line declining in the 2%-3% range, FCF turning negative, and adjusted debt/EBITDAR that starts trending meaningfully above the 5x range.
LIQUIDITY
SVU's liquidity is adequate, supported by a $1 billion ABL credit facility, with a borrowing base management estimates will range from $900 million to $1 billion. The borrowing base totaled $947 million as of Feb. 28, 2015, against which the company had no borrowings and $76 million of letters of credit. In addition, absent a separation of Save-A-Lot, Fitch projects FCF to be around $100 million-$150 million annually over the next three years.
FCF would also be positive assuming a spin-off of the Save-A-Lot business.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
SUPERVALU INC.
--IDR at 'B';
--$1 billion secured revolving credit facility at 'BB/RR1';
--$1.5 billion secured term loan at 'BB/RR1';
--Senior unsecured notes at 'B/RR4'.
The Rating Outlook is Stable.
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 12 Jun 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=867275
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=988673
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