DBRS Confirms Safeway Ratings at BBB, R-2 (middle)

DBRS has today confirmed the Issuer Rating and Senior Unsecured Debt rating of Safeway Inc. and the Second Series Notes rating of Canada Safeway Limited (guaranteed by Safeway Inc.; collectively, with Safeway Inc., Safeway or the Company) at BBB and the Company’s Commercial Paper ratings at R-2 (middle), all with Stable trends. The confirmation reflects the recent stabilization of operating performance in the United States, as well as asset sales, part of the proceeds of which are expected to be used to reduce debt by a meaningful level. Safeway’s ratings continue to be supported by its strong brand, large relative scale and geographic diversification in the United States. The ratings also reflect the intense competitive environment in U.S. food retail, the Company’s lack of format diversification, sensitivity to economic cycles and its high relative cost structure.

On June 13, 2013, DBRS confirmed Safeway’s ratings, following the Company’s announcement that it had entered into an agreement to sell its Canadian operations through a sale of the net assets of Canada Safeway to Sobeys Inc. for CAD $5.8 billion in cash (approximately $4.0 billion in proceeds after taxes and expenses). Canada Safeway generated approximately $6.7 billion in revenue and $544 million in EBITDA in the LTM ended Q1 2013, accounting for approximately 15% of the Company’s consolidated revenue. Safeway has indicated that proceeds from the sale will be used to repay approximately $2 billion of existing indebtedness, with the remainder available for share repurchases or investment in growth opportunities.

Subsequent to Q3 2013, Safeway also announced its intention to exit the Chicago market by the end of 2014, where it operated 72 Dominick’s stores. The sale of Dominick’s stores is expected to result in a cash tax benefit of $400 million to $450 million, which will partially offset the cash tax expense and therefore increase the expected net proceeds from the sale of Canada Safeway. Dominick’s generated losses before taxes of $35.2 million through Q3 2013.

On April 22, 2013, Safeway completed its initial public offering of Blackhawk Network Holdings, valued at approximately $1.35 billion. The IPO generated proceeds of approximately $230 million, as Safeway retained a significant majority ownership interest of approximately 73%.

Going forward, Safeway’s earnings profile is expected to remain relatively stable and within a range considered acceptable for the current rating category in the near to medium term, subsequent to the sale of Canada Safeway Limited. Revenues on a comparable basis are expected to increase in the low- to mid-single-digit range in 2014, based on continued improvement in identical store (ID) sales and volumes as the Company leverages its existing sales initiatives (i.e., its “just for U” program) and refocuses on core geographies. EBITDA margins on a comparable basis should remain relatively stable in the near term, but could benefit over the medium term as the Company optimizes its strategies in relation to price investments and shrink. EBITDA on a comparable basis is therefore expected to improve modestly in the near to medium term.

In terms of financial profile, DBRS expects Safeway’s leverage will complete its return to a level considered acceptable for the current rating category as the Company uses cash generated from the sale of Canada Safeway Limited to repay approximately $2 billion in balance-sheet debt in the near term. Cash flow from operations should continue to track operating income, while capex is expected to decline in line with the Company’s recent sale of assets. Dividends are expected to continue to increase steadily over the medium term. Free cash flow before changes in working capital is expected to be in the $250 million to $350 million range in 2014. Balance-sheet debt is expected to decline toward the $3.5 billion level in the near term as Safeway uses $2 billion generated from asset sales to repay balance-sheet debt, which should result in a material improvement in credit metrics (i.e., lease-adjusted debt-to-EBITDAR below 3.0 times (x)). Should credit metrics not return to levels considered acceptable for the current rating category (i.e., lease-adjusted debt-to-EBITDAR below 3.0x) due to weaker-than-expected operating performance or more aggressive than expected financial management (i.e., insufficient debt reduction), a negative rating action could result.

Notes:
All figures are in U.S. dollars unless otherwise noted.

Ratings for Canada Safeway Limited are based on the full and unconditional guarantee of Safeway Inc.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodology is Rating Companies in the Merchandising Industry, which can be found on our web site under Methodologies.