CDS shows market still wary of new Safeway strategy

June 22 (IFR) - Safeway saw its credit default swaps (CDS) pitch to historical wides of 375bp last week, driven by rumors that it was having trouble accessing the commercial paper market.

The grocery chain, whose CDS widened 92bp in one week alone, typically meets its working capital needs via CP -- and as of June 5, it had $701m outstanding in that market.

The rumors began earlier in June when Safeway, which rarely borrows with floating rate notes, issued a $250m 18-month FRN -- something it had not done in six years.

Though the floating rate deal was opportunistic, it fueled so much speculation that the company went public in insisting that it was not having difficulties accessing CP.

Melissa Plaisance, senior vice president of finance and investor relations, told a conference call last week that the FRN was intended to tap a more diverse investor base at an attractive rate.

It was a substitute for CP and not incremental debt, she said, and went on to explain why the company had opted to up its share repurchases to $1bn in the fourth quarter of 2011.

Plaisance outlined some of the thinking behind that shift -- which has led to Safeway being downgraded by both Fitch and Moody's.

'TEMPORARY SHIFT'

In Q411, the company tacked on leverage by issuing $800mln in senior notes split in 5s and 10s, and arranged a $700mln term loan.

Part of the proceeds went to refinance the $800mln coming due August 15, 2012, which is a credit positive, but part also went to fund the increase in share buybacks -- a credit negative, and a change in Safeway's prior strategy.

Plaisance termed it a "temporary shift in company policy", but whether temporary or not, the markets have reacted skeptically.

In November, Fitch cut Safeway to BBB- from BBB with a stable outlook, and Moody's in January lowered it to Baa3 from Baa2, also with a stable outlook. (S&P rates Safeway at BBB.)

Moody's also cut the CP rating to Prime-3 from Prime-2. Both agencies cited the aggressive nature of Safeway's new financial policy.

Meanwhile the company's spreads, which were in the 130bp region in January/February, have widened nearly 250bp since then.

In the conference call, Plaisance said Safeway had met with the ratings agencies before the policy shift and that the company was committed to remaining investment-grade.

She said the company "can navigate well with the one notch downgrades, as the requirements of working capital fluctuate from week to week."

LEVERAGE

Though the additional leverage was crucial for funding the share repurchase, Plaisance said that Safeway intends to bring its credit metrics back in line with Q311 levels by the end of 2013.

The company hopes to regain the one-notch downgrades and retain a "sweet spot" mid-BBB /stable, which would provide flexibility.

CDS spreads were reassured by the conference call, and receded 41bp to 334bp. But synthetic spreads remain pressured.

From a relative value perspective, grocery store names are trading at all-time wides versus comparable sectors such as industrials, analysts from Barclays said in a recent report.

Safeway is partially responsible for this, due to the aggressive share buyback. But all grocery chains have a host of challenges which must continually be overcome, and Safeway has underperformed its peers in the past in areas such as margins.

CDS widening is expected to persist in the intermediate term, the Barclays analysts said, as market technicals in Safeway are currently being driven by a high-yield base.

They said they expected a lack of conviction to continue -- until Safeway clearly reverses course and begins seriously deleveraging.

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