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Fitch Affirms Ahold Delhaize at 'BBB'; Outlook Changed to Positive
October 31, 2017 / 6:25 PM / in 23 days

Fitch Affirms Ahold Delhaize at 'BBB'; Outlook Changed to Positive

(The following statement was released by the rating agency) PARIS/MILAN, October 31 (Fitch) Fitch Ratings has affirmed US and European food retailer Ahold Delhaize NV's Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB'. The Outlook has been changed to 'Positive' from 'Stable'. The Outlook change reflects our expectation that Ahold Delhaize's credit metrics should improve over the rating horizon to a level commensurate with a 'BBB+' rating. Ahold Delhaize displays an enhanced business profile since the merger which took place in July 2016. The group now benefits from larger scale, and is a very relevant player in several states of the U.S. with well recognised local brands. It also remains the market leader in the Netherlands and in Belgium. The group has strong credit metrics, and we expect leverage to improve over the next few years thanks to free cash flow (FCF) generation capacity. However, a persisting and severe deflation in the US food retail market or a financial strategy aimed at returning high levels of cash to shareholders could prevent this de-leveraging, and lead us to move back the Outlook to Stable. KEY RATING DRIVERS Enlarged Group in the US: Following the merger, the group has positioned itself as the fifth-largest retailer in the U.S., and sixth-largest in Europe, with 2016 pro-forma revenues reaching EUR62.3 billion. Growing scale is essential in the food retail industry where it is critical to have strong negotiating power with suppliers. This allows the preservation of profit margins, which are traditionally thin. Ahold Delhaize has stated that it has already benefited from price renegotiations with suppliers. Greater scale is also necessary to be able to face the pressure on prices imposed by the market leader, and in particular by Walmart in the US. Solid European Base: Ahold Delhaize also enjoys a strong footprint in the Netherlands and in Belgium and it holds the undisputed leading position in both countries. This enhances the group's geographical diversification, even though the European food retail market is mature and very competitive as well. Belgium saw a decline in in like-for-like sales and profitability in 1H17. The group only benefits slightly from the growth potential of less mature countries such as Romania or Serbia, as it only has a small presence in non-OECD countries. Synergies on Track: The group has announced that the initially planned total synergies of EUR500 million will be exceeded, and should reach EUR750 million by 2019. The additional EUR250 million will be re-invested in its brands, in order to enable more promotional campaigns than planned and increase footfall into the stores. This performance indicates that execution risks linked with the merger, in the U.S. in particular, have been well addressed so far. The group announced it is well on track to reach EUR220 million of synergies by end 2017. As a consequence, we expect its EBIT margin to increase slightly over the next years from 3.7% of pro forma revenues in 2016 to 3.9% in 2018-2019. Difficult U.S. Market: The food retail sector remains highly competitive in most countries, especially in the U.S. The price war initiated by the sector leader Walmart a couple of years ago continues and we do not expect it to soften in the near future. The merger between Ahold and Delhaize was a defensive tactic against this trend, but pressure on prices continues, coupled with changing consumer habits (omni-channel, multi-services, online shopping, with the much commented "Amazonification" of the sector). Strong Financial Flexibility: The group enjoys a strong liquidity profile with a large available cash balance and an undrawn syndicated facility of EUR1 billion. However it has high fixed costs, in the form of interest payments but also fixed leases. Interest cost is likely to decrease in future with expensive existing debt being gradually refinanced with cheaper debt (such as the inaugural EUR750 million seven-year Eurobond launched in September 2017 with a coupon of 0.875%). The group has high fixed lease obligations (estimated by Fitch at EUR1.1 billion per year), but the FFO fixed charge cover ratio should stay at a satisfactory level of well above 3.0x, which remains comfortable for the 'BBB' rating category. Fixed leases should remain stable unless the company has the opportunity to re-negotiate them, or does not renew the maturing ones. Deleveraging Capacity: The group delivers positive FCF which allows substantial deleveraging. Fitch projects that its leverage ratio could decrease over the next few years, from an estimated pro forma post-merger FFO adjusted net leverage ratio of 2.8x to 2.6-2.5x, if capex stays in line with the level announced for 2017, and with only small bolt-on acquisitions. With these credit metrics the group retains headroom to withstand the risk of a long lasting price war in the U.S., while also satisfying its shareholder-friendly financial policies. The Positive Outlook reflects the potential resilience of leverage to these circumstances. Cash returned to shareholders: Five months after the merger the group announced a EUR1 billion share buy-back programme, to be completed by end-year 2017. Returning cash to shareholders seems to be a key pillar of the group's financial strategy. In terms of dividends, the group has announced a pay-out ratio of 48% of 2016's pro forma underlying income from continuing operations, and it is likely that the group may not want to go below this percentage over the next few years. This financial strategy limits the deleveraging prospects of the group, but given the current and forecast credit metrics, the company could afford it. DERIVATION SUMMARY Ahold Delhaize's IDR is positioned lower than Target (A-/ Negative), which is of comparable size but more profitable, with a much stronger FFO fixed charge cover and with lower FFO leverage. Compared to Kroger (BBB/Negative), Ahold Delhaize has a comparable leverage ratio, but Kroger's ratio is deteriorating on a forward-looking basis while Ahold Delhaize's is improving. Kroger benefits from a much larger scale and higher FFO fixed charge coverage, but is less profitable. Ahold Delhaize has reinforced its negotiating power with suppliers since its merger in 2016, but remains significantly smaller and more leveraged than Costco (A+/Stable), while Walmart (AA/Stable) has unmatched scale, and a low leverage, which should enable it to remain the undisputed leader in the current war price in the U.S. food retail market. Compared with its European peers Ahold Delhaize's rating is one notch lower than Carrefour's (BBB+/Stable), which is more diversified in terms of product offering and geographies, but higher than Tesco (BB+/Stable) or Casino (BB+/Stable) which are less profitable and significantly more leveraged than Ahold Delhaize. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - sales of around 1% per year, slightly decreasing sales in the U.S. but increasing in Europe. - EBIT margin increasing by 0.2% (20bp) by 2020, due to the successful implementation of synergies linked with the merger. - capital expenditure staying at a rather high level of EUR1.8 billion, the level announced by the group for 2017, due to continued investments in online sales, omni-channel and stores remodelling. - dividends increasing by around 10% per year. - a new EUR1 billion share buy-back plan in 2019 (Fitch modelling assumption). - no major acquisitions. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Positive like-for-like sales growth in core markets leading to sustained gains in market shares, not at the expense of EBIT margin, and a successful integration in the US and Holland/Belgium - FFO fixed charge coverage above 3.0x - FCF margin staying at around 2% on a sustained basis - Lease-adjusted FFO net leverage consistently below 3.0x Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - EBIT margin falling consistently below 3.5%, due to intense competition in core markets or linked to any meaningful disruption created during the integration process. - FFO fixed charge coverage falling below 2.5x - FCF neutral or mildly negative - Lease-adjusted FFO net leverage trending towards 4.0x, driven by either sustained operating underperformance or a more aggressive financial policy following the merger LIQUIDITY Strong Liquidity: Ahold Delhaize has access to a EUR1 billion committed multi-currency line, which matures in 2021, which was undrawn as of 1 January 2017. The company had EUR4 billion of cash on its balance sheet at FYE16, of which EUR1.2 billion was held in the context of a notional cash-pooling arrangement, to offset a corresponding amount of short-term debt. This pooling structure enables the group to move cash balances among subsidiaries and ensures smooth operational liquidity. In July 2017 the group set up a multi-currency ECP programme of EUR1 billion, for which the above mentioned EUR1 billion committed line should serve as back-up line. There was EUR250 million of ECP outstanding as of 9 August 2017. FULL LIST OF RATING ACTIONS Contact: Primary Analyst Sophie Coutaux Senior Director Fitch France SAS 60, rue de Monceau 75008 Paris +33 (0)1 44 29 91 32 Secondary Analyst Anne Porte Director Fitch France SAS 60, rue de Monceau 75008 Paris +33 (0)1 44 29 91 36 Committee Chairperson Giulio Lombardi Senior Director +39 02 879087 214 Media Relations: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Summary of Financial Statement Adjustments - Leases: Fitch adjusts pro-forma merged group debt amount by adding 8x of yearly operating lease expense to long-term assets. A multiple of 8.0x was used as the assets are essentially in the U.S. and Western Europe. - Cash: Fitch adjusts reported cash in 2016 by deducting restricted cash mentioned by the company, and for average peak-to-trough working capital purposes. We estimate the total at EUR222 million pro-forma for Ahold Delhaize in FY16. - Fair Value of Debt: A number of debt instruments were swapped and we consider the nominal amount to repay rather than the reported fair value. At end 2016 the difference was EUR377 million which we deduct from the amount of reported debt Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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