Safeway CDS trading at virtual junk levels

Fri Aug 16, 2013 3:03pm EDT

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Aug 16 (IFR) - Five-year credit default swaps (CDS) in US supermarket chain Safeway are trading at levels that essentially consider the investment-grade company's debt as junk-rated bonds - and that's unlikely to improve in the short to medium term.

Protection buying has climbed in the past three months, pushing five-year CDS in California-based Safeway 50bp wider as a series of business and strategic decisions have been seen in the markets as credit negative.

It sold off some CAD4.0bn of Canadian assets in the second quarter to help pay down debt - but rating agency Moody's revised Safeway's outlook to negative on the move, as the Canadian operations had a higher Ebitda margin and generated better cash flow than their US counterparts.

And Safeway's second-quarter results, while in line with consensus expectations, were down year-on-year.

According to data from Markit, CDS in Safeway (BBB /BBB-/Baa3) is trading at 215bp or an implied rating of BB, which is fully into junk-bond status.

Moody's says any improvement to the company's credit metrics from the asset sale will only be modest, while rival agency Fitch said the decision to pay down debt would still only bring Safeway's leverage back to levels seen before it began an accelerated debt-financed share buyback program in 2011/2012.

For Fitch, concerns about identical store sales over the next few quarters are key to "stabilizing the rating outlook".

During the second quarter, identical store sales fell 1.0% versus the year-ago period, when they increased 2.1%.

Safeway said it anticipates non-fuel same-store sales growth of 1.5% to 2.0% for 2013, which is lower than it originally forecast. Moreover, while inflation is expected to remain quelled for the second half of the year, identical store sales are expected to remain essentially flat.

Combined with an earnings per share forecast set at the lower end of its prior outlook of $2.25 to $2.45 and the company's intention to repurchase shares, Safeway's ability to bolster its credit quality looks limited - which can only increase odds in the intermediate term of an actual move into high-yield territory.

Even so, the chain's bonds have been relatively solid in the secondary market. The SWY 3.4% 2016s, quoted at T+151bp at the end of May, were quoted at T+137bp on Friday.

Its 4.75% 2021s were quoted at a spread of +250 spread on Friday - virtually unchanged from +251 on May 31.

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