DBRS Confirms Safeway’s Long-Term Debt at BBB and Downgrades CP to R-2 (middle)

DBRS has today confirmed the Senior Unsecured Debt rating of Safeway Inc. and the Second Series Notes rating of Canada Safeway Limited (collectively, with Safeway Inc., Safeway or the Company) at BBB and downgraded the Company’s Commercial Paper rating to R-2 (middle) from R-2 (high); the trends are Stable. These rating actions follow Safeway’s announcement that it has increased the authorized level of its stock repurchase program, which had $0.9 billion remaining (at the end of Q3 2011), by $1.0 billion; is issuing $800 million of senior unsecured notes; and plans to incur $700 million of bank term debt in the first half of 2012.

At the same time, DBRS has assigned a rating of BBB to the Company’s new issue of $800 million senior unsecured notes, which comprises two tranches:
– $400 million five-year 3.4% notes.
– $400 million ten-year 4.75% notes.

Safeway is expected to use the proceeds of the notes issuance, along with the planned $700 million term loan, for general corporate purposes, including funding share repurchases and the repayment of debt. DBRS expects this plan will increase financial leverage, resulting in the key credit metric lease-adjusted debt-to-EBITDAR peaking at approximately 3.3 times (x; capitalization of operating leases is based on a 6.0 multiple) between Q1 2012 and Q2 2012 versus the current level (i.e., for the last 12 months (LTM) ending September 30, 2011) of 2.8x.

DBRS’s confirmation of the long-term rating is based on the expectation that the higher leverage levels will be temporary and should recover to levels that are more appropriate for the current rating by the end of 2013. The Company is expected to achieve this through a combination of growth in operating income, the monetization of certain assets and the application of an appropriate level of free cash flow toward debt reduction.

The moderate improvement in operating performance displayed by Safeway through the course of 2011, following very difficult years in 2009 and 2010, is expected to continue through 2012 and 2013. Such improved performance will only help strengthen Safeway’s already strong free cash flow generating capacity ($700 million to $800 million per year), which should provide the needed ability to reduce debt. Furthermore, DBRS believes that management is committed to reducing debt to appropriate levels by the end of 2013.

Should it become apparent that the Company will not succeed in returning credit metrics to current levels by 2013 because of weaker-than-expected operating performance (e.g., flat or negative EBITDA growth) or financial management that fails to reduce debt as necessary, a negative rating action will result.

SHORT-TERM RATING
In terms of liquidity, DBRS methodology typically couples a long-term rating of BBB with a short-term rating of R-2 (middle). Safeway’s R-2 (high) Commercial Paper rating was considered an exception because of its very strong free cash flow generating capacity. DBRS believes that debt incurred to increase share repurchases over the next 18 months has weakened Safeway’s liquidity and its position within the BBB rating category. As such, Safeway is no longer considered an exception and DBRS believes the appropriate short-term rating is R-2 (middle).

Should it become apparent that Safeway will be successful in completing its plan and returning credit metrics to appropriate levels, a positive short-term rating action could result, irrespective of any positive long-term rating actions.

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

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