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Fitch Ratings Goes 'Negative' on Grocery's Big Three

NEW YORK -- Fitch Ratings today affirmed the 'BBB' ratings on Kroger, Albertsons, and Safeway, revising its outlooks on Kroger and Albertsons to "negative" from "stable," and keeping its outlook on Safeway "negative" as well.

Of its credit ratings for the nation's three leading supermarket operators, Fitch said its negative outlooks reflect the long-term pressures facing the supermarket sector, including intensified competition, and the expectation that the weakened operating margins could persist.

Fitch said brutal competition has forced Kroger to face increased promotional activity and changing shopping patterns among consumers. To address this, Kroger has continued to focus on customer service and product selection while it continues to improve pricing parity to its nontraditional retail competition. This has resulted in the company reporting positive comparable store sales for the last four quarters (excluding fuel sales and Southern California in 2004). However, it also eroded Kroger's operating margins, with EBITDAR margin declining to 6.5 percent for the 12 months ended May 21, 2005, down from 7.1 percent in fiscal 2003 and 8.5 percent in 2002.

Fitch said it expects that Kroger will continue to grow its sales as it invests in competitive pricing and service, bit operating margins will remain pressured even as benefits from the large number of labor contracts the chain renegotiated over the past 18 months are recognized. In addition, continued competitive pressures across all markets, including heightened promotional activity in Southern California aimed at regaining market share following the 2004 labor strike, is expected to persist. Fitch said it anticipates that Kroger will continue to execute a strategy of using two-thirds of free cash flow to buy back shares, and one-third for debt retirement. In light of the weak operating environment, this capital allocation strategy could further pressure credit metrics, the firm said.

Of Albertsons, Fitch said would continue to monitor the company's portfolio-shaping activities, operating trends, including same store sales, capital allocation, and the impact of such results on credit statistics. While Fitch expects Albertsons' operating profitability to benefit from new labor contracts and its internal cost-cutting initiatives, these gains are expected to be offset by continued promotional activity in Southern California as well as continued competitive pressures affecting all operating markets.

Fitch noted Safeway's strategy of new stores and remodels around the Lifestyle prototype, which focuses on fresh food offerings, service, and prepared meals. Results at the newly renovated stores, with 180 completed at the end of the first quarter, have been promising, Fitch said, and differentiates Safeway from competitors. Furthermore, Fitch said, the new store prototype gives the company the chance to reintroduce itself to customers with a new store image, which might help in regaining lost sales in subsidiaries such as Genuardi's, Dominicks, and Randalls.

Fitch said it expects Safeway's operating margins to stabilize as the company recovers from weakness in California, and as it continues to execute the remodel strategy. Cash flow is expected to be deployed to fund capital expenditures, including the company's Lifestyle store remodel program, the newly initiated dividend of $90 million per year, and near-term debt maturities, of about $500 million. As a result, credit measures are expected to improve from current levels; however, given the continued competitive operating environment, the pace and degree of the improvement may be constrained.
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