DBRS Confirms Safeway Inc. at BBB, R-2 (high), Stable Trends

DBRS has today confirmed the Senior Unsecured Debt and Commercial Paper ratings of Safeway Inc. (Safeway or the Company) at BBB and R-2 (high), respectively, and the Commercial Paper rating of its wholly owned subsidiary, Canada Safeway Limited (Canada Safeway), at R-2 (high). The trends remain Stable.

Safeway’s ratings continue to be supported by its position as the third largest food retailer in the United States. Its 1,725 store base (F2009) is geographically diverse (western U.S.A., Chicago, mid-Atlantic and western Canada), with a number-one or number-two share in most of its markets. Even so, Safeway’s performance has been under pressure in 2009 and 2010, due mainly to the economic downturn. The deflation in food prices (particularly in dairy and produce) during 2009 continued into 2010, pressuring margins. This was driven by increased competition, accelerated promotional pricing and price matching. So far in 2010, revenue growth is nil (year-over-year) while EBITDA has declined 10% (year-over-year). This was based on a 2.4% decline in same stores sales (excluding fuel) and fewer stores in operation.

Consumers remain cautious with the economy still weak and unemployment rates high, resulting in lower spending. Consumers are turning more to discount supermarkets for grocery items, which is not Safeway’s prime target market. Safeway operates primarily in a one store format with the same general mix of products, with similar pricing. It does not operate supercentres, warehouse stores or discount stores. With this intense competition, the Company had to counter by making higher levels of price investment. Safeway’s volumes have started to improve as consumer perception of its higher pricing fades. Safeway expected that current pressures would remain significant throughout F2010 and revised its earnings guidance earlier in the year.

Operating earnings fell during 2009 and again in 2010, with lower same-store sales. EBTITDA margins for the 12 months ended September 11, 2010, fell to 5.7% compared with 6.2% for F2009 and 6.8% for F2008. As a result, Safeway’s cash flow from operations continued to decline in 2010, but should exceed $1.5 billion. Capex is expected to be about $900 million and dividends about $180 million. Hence, DBRS expects free cash flow to remain strong between $900 million and $1.1 billion but below 2009 levels due to a large tax refund. Its lease-adjusted debt-to-EBITDAR rose to 2.88 times and lease-adjusted debt-to-capital rose to 62.4%. These are at the upper end of acceptable ranges for the current rating.

DBRS expects that as the economy turns, Safeway’s performance will improve as it makes it way through this downturn. The Company has made a significant investment in the store base with its Lifestyle format and in its private label product lines which will continue to help underpin its market share. For Safeway to maintain a stable financial profile to keep it well placed in the BBB category, it would need to use the free cash flow to continue to strengthen its balance sheet.

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

The applicable methodology is Rating Food Retailers, which can be found on our website under Methodologies.

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