Fitch: Save-A-Lot Sale Neutral to SUPERVALU'S 'B' IDR

CHICAGO--()--SUPERVALU Inc.'s (SVU) definitive agreement to sell Save-A-Lot for $1.365 billion is neutral to the company's Issuer Default Rating (IDR), according to Fitch Ratings.

Fitch's affirmation of SVU's 'B' IDR on Sept. 7, 2016 contemplated the possible divestiture of Save-A-Lot, potential proceeds, and any corresponding debt paydown. Upon transaction closing and corresponding debt reduction, Fitch will evaluate SVU's post separation capital structure and adjust issue-level ratings for the various tranches of remaining debt based on the amount of term loan debt paydown and updated recovery model excluding Save-A-Lot.

The transaction price values Save-A-Lot at about 6.7x the segment's $203 million of latest-12-month (LTM) June 18, 2016 EBITDA and was in line with Fitch's expectations of 6x - 8x. SVU intends to use net proceeds to prepay at least $750 million of its $1.4 billion term loan due 2019, to further reduce debt, and to fund corporate and growth initiatives for its remaining business. The sale is expected to be completed by Jan. 31, 2017, subject to regulatory approvals and other customary closing conditions.

At June 18, 2016, SVU had $2.5 billion of total debt. SVU's credit agreements require the first $750 million of proceeds and up to 50% of proceeds above $750 million for net secured leverage to be 1.5x to be used to repay its term loan. The term loan is backed by certain real estate (mainly retail stores and distribution centers) with a book value of $793 million (as of June 18, 2016) and an estimated market value of $1 billion, and a pledge of the shares of Moran Foods, LLC (Save-A-Lot).

Fitch projects $750 million of debt reduction will be required to bring the net secured leverage ratio down to 1.5x and therefore does not contemplate significant additional debt paydown. Pro forma total adjusted debt/EBITDAR, based on LTM EBITDA of $569 million excluding Save-A-Lot, $1.8 billion of debt and $98 million of rent expense, is 3.8x. However, Fitch anticipates that leverage will increase to the low 4x range as sales and operating earnings in its remaining wholesale and retail businesses remain under pressure.

Key Rating Drivers

Weak Revenue, Earnings Trends:

SVU's revenue fell 3.9% to $5.2 billion in the first quarter ended June 18, 2016, after declining 1.6% to $17.5 billion in fiscal 2016 (February). Excluding the impact of the 53rd week in fiscal 2015, sales were essentially flat. Low- to mid-single-digit identical store (ID) sales declines at Save-A-Lot and retail, along with business losses and reduced revenue from existing clients in the wholesale segment, are having a negative impact on revenue.

For SVU's retail segment, Fitch expects mid-single-digit ID sales declines for fiscal 2017. Gradual improvement should occur in fiscal 2018 due to price investments and improved store-level execution but Fitch expects SVU's retail banners will continue to be share donors over the long term. Gross margin contraction and operating earnings declines could continue absent significant cost reductions. Fitch projects segment EBITDA of about $200 million in fiscal 2017 from $248 million in fiscal 2016 and below $200 million in fiscal 2018.

Although SVU expects to consummate the divestiture of Save-A-Lot before the end of fiscal 2017, Fitch expects low-single-digit ID sales declines for fiscal 2017 for this segment. Segment EBITDA is projected to be approximately $200 million in fiscal 2017.

Fitch expects segment sales in wholesale to decline at a low-single-digit rate in fiscal 2017 even as revenue from new business, particularly from Marsh Supermarkets and The Fresh Market, starts to materialize. Absent additional customer losses, mid-single-digit sales growth is anticipated for fiscal 2018 as the full benefit of this new business is realized.

Wholesale segment EBITDA is projected to be approximately $270 million in fiscal 2017 and $300 million in fiscal 2018 but modest margin contraction is expected given the likelihood that larger-sized contracts come at a lower margin. SVU will have to offset what Fitch expects will be a 2%-3% attrition rate in its existing business with new business wins in order to maintain the revenue and EBITDA base in this segment.

Long-term Challenges for Wholesale and Retail Business

Based on Fitch's fiscal 2017 forecast, SVU's wholesale and retail segments will represent 63% and 37%, respectively, of the company's revenue and EBITDA post the separation of Save-A-Lot. Fitch recognizes SVU's focus on its wholesale operations and recent new business wins but expects the wholesale and retail operating environment to remain challenged longer term due to competitive pricing and consolidation and restructuring in the grocery industry. Excluding Save-A-Lot, Fitch projects EBITDA of about $530 million in fiscal 2017, down from $584 million in fiscal 2016. Fitch anticipates that EBITDA could decline to below $500 million, absent continued cost reductions, due to on-going revenue and margin pressure.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to an upgrade include stable market share trends; total adjusted debt/EBITDA sustained below 4.0x; relatively stable margins; and positive FCF.

Future developments that may, individually or collectively, lead to a downgrade include consistently weak top line performance across each of the company's businesses and margin contraction that lead to negligible or negative FCF.

Fitch currently rates SVU as the follows:

SUPERVALU INC.

--Long-Term Issuer Default Rating 'B';

--$1 billion secured revolving credit facility 'BB/RR1';

--$1.4 billion secured term loan 'BB/RR1';

--$750 million senior unsecured notes 'B/RR4'.

The Rating Outlook is Stable.

Additional information is available at www.fitchratings.com.

Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:

--Historical and projected EBITDA is adjusted to add back non-cash stock based compensation expense as reported in financials.

--Fitch views operating leases as debt-like obligations so capitalizes gross rent expense using a multiple of 8x.

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or
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Contacts

Fitch Ratings
Primary Analyst
Carla Norfleet Taylor, CFA, +1-312-368-3195
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Monica Aggarwal, CFA, +1-212-908-0282
Managing Director
or
Media Relations
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@fitchratings.com