TEXT-S&P raises Whole Foods rating to 'BBB-' from 'BB+'
Aug 7 - Overview -- U.S. natural food retailer Whole Foods Market has enhanced credit protection measures with considerable profit growth reflecting higher comparable-store sales and new smaller and more productive stores, trends we expect to continue. -- We are raising our corporate credit rating on the company to 'BBB-' from 'BB+'. -- The stable outlook incorporates our expectation that strong sales and profit growth trends will continue, at least for the near term. Rating Action On Aug. 7, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on Austin, Texas-based Whole Foods Market Inc. to 'BBB-' from 'BB+'. The outlook is stable. Rationale The rating action comes after Whole Foods' strong operating trends. Its EBITDA growth over the past year of about 21% has been somewhat better than we anticipated and has enhanced credit protection measures meaningfully. Given our operating forecast, we anticipate further improvement. Moreover, the company has generated significant discretionary cash flow, and it now has sizable excess cash. With expected capital expenditures and likely dividend payments, we foresee Whole Foods generating further excess cash in the future. The rating on Whole Foods reflects our assessment of its business risk as "satisfactory," which incorporates the company's strong position as the leader in the organic and natural food retailing sector, and our expectation that it will continue to outperform traditional grocery stores in the near and intermediate term. We also revised our assessment of Whole Foods' financial risk to "intermediate" from "significant." This is based on the company's strong cash flow generation and forecasted credit ratios. The company's third-quarter results were slightly better than our expectations and meaningfully better than traditional grocery stores. Although we expect tepid economic expansion and sustained high unemployment, we believe such conditions will not inhibit performance at Whole Foods, since the natural and organic segment industry is growing considerably faster than the food retail industry as a whole. Furthermore, the company's pricing, promotional, and merchandising strategies have driven transactions and customer loyalty. Consequently, we believe the company is now less vulnerable to downturns in consumer spending. With these industry and economic conditions, our base line forecast assumptions are as follows: -- We expect annual comparable-stores sales increases to approach 9% in 2012 and to increase about 7% in 2013; -- Total revenue growth in 2012 of approximately 16% in 2012 and around 12% in 2013; the more moderate revenue growth in 2013 incorporates that it will be a 52-week fiscal year relative to 2012, a 53-week fiscal year; -- EBITDA margins expansion of about 60 basis points (bps) in 2012 and about 20- to 40-bp expansion in 2013; -- Overall EBITDA in 2012 of about $1.05 billion and EBITDA in 2013 about $1.2 billion; and -- 6%-8% annual growth of operating lease-adjustment to debt over the next two years, a similar growth rate of total retail square footage. These performance scenarios would lead to the following credit ratios: -- Adjusted debt to EBITDA of 2.6x in 2012 and about 2.3x-2.4x in 2013; -- Adjusted EBITDA interest coverage of 4.6x in 2012 and about 5x area in 2013; and -- Funds from operations (FFO) to debt of 24% in 2012 and near 26% in 2013. The forecasted ratios are generally commensurate with an "intermediate" financial risk profile. We believe that Whole Foods' recent sales performance is a result of its more aggressive marketing and pricing strategies. We also believe that the company will generally pass along food inflation to consumers and maintain gross margins. We also see operating margins benefiting from higher sales volumes. Whole Foods may price aggressively on certain items or increase promotions to gain market share, but we do not expect such activities to hurt gross margins significantly. Liquidity We view Whole Foods' liquidity as "adequate" and we expect its sources of liquidity to be greater than its uses over the next two years by a ratio of at least 1.2 to 1.0. Sources, as of July 1, 2012, include $135 million of unrestricted cash, $933 million of short-term investments, proceeds associated with the exercise of employee stock options, and FFO over the next year of about $1 billion. Since the company's revolving credit facility matures this month and we do not expect it to be renewed, we do not consider it a source of liquidity. We primarily expect cash uses to include working capital investment associated with new stores, capital spending near $500 million, and dividend payments. We expect discretionary cash flow to approach $400 million over the next year. Relevant aspects of Whole Foods' liquidity, in our view, are as follows: -- We see coverage of uses by sources in excess of 1.2x for the next two years; -- We expect that sources will exceed uses, even with a 15% drop in EBITDA; and -- No near-term maturities. Outlook Our stable rating outlook on Whole Foods incorporates our expectations that the overall sales and profit growth trends should be strong in the near term. Nonetheless, we expect credit ratios to remain appropriate for our current financial risk assessment and rating category. If the company performs better than we anticipate, we would consider a higher rating. For example, if debt to EBITDA was in the low-2x area and FFO/debt was in the 30% range, we may consider a higher rating. We estimate this could occur in 2013 if EBITDA grew around 27%-29% and would track toward $1.4 billion, while operating lease commitments only grew 7%-8%. However, we would want to be sure that the company's financial policies would be such that future capital allocations would ensure that the company maintains credit ratios near those levels and liquidity remained adequate. Given the company's performance trends, we do not consider a downgrade as likely in the near term. However, we may consider a lower rating if the company adopts more aggressive financial policies and adds funded debt to finance returns to shareholder or acquisitions. However, we do not view either as likely. If leverage rises above 3x, we may consider a lower rating. With our estimated profitability and debt levels at the end of 2012, Whole Foods could increase debt by $500 million and be near that threshold. Related Criteria And Research -- Issuer Ranking: U.S. Restaurants & Retail, Strongest To Weakest, April 30, 2012 -- Industry Report Card: Our Credit Outlook Remains Slightly Negative For The U.S. Retail Industry This Year, April 30, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Key Credit Factors: Business And Financial Risks In The Retail Industry, Sept. 18, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Upgraded; Outlook Action To From Whole Foods Market Inc. Corporate Credit Rating BBB-/Stable/-- BB+/Positive/-- Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.