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Dec 5, 2011
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U.S. retailers shifting to aggressive financial policies

By
Reuters
Published
Dec 5, 2011

Fitch Ratings believes that our November downgrades of Lowe's Companies, Inc. (Lowe's) and Safeway, Inc. (Safeway), both a result of a more aggressive share repurchase posture, indicate a heightened risk that other U.S. retailers may follow a similarly aggressive path.


Stock exchange bill board / Photo: Corbis

Investment-grade retailers are becoming more shareholder-friendly, as the combination of attractive stock valuations and historically low interest rates are proving irresistible to many management teams. This will likely continue into 2012 as many companies maintain an aggressive share repurchase posture within the context of their existing ratings, while some may choose to accept lower ratings.

Recent examples include Safeway, which was downgraded by one notch to 'BBB-' following its announcement that its board of directors authorized a $1 billion increase in its share repurchase authorization (under which $0.9 billion was unused at the end of the third quarter). This was done at the same time the company issued $800 million of new senior notes and received a commitment for a new $700 million term loan.

In addition, Lowe's recently raised its adjusted leverage target to 2.25x from 1.8x, creating an additional $3 billion of debt-financed share repurchase capacity, which led to a two-notch downgrade to 'BBB+'.

Also, The Gap, Inc. reentered the debt markets in April, issuing $1.65 billion of new debt for share repurchases, pushing adjusted leverage from 2.5x to the mid-3x range. In most cases, companies are choosing to take advantage of whatever "excess borrowing capacity" exists within their existing ratings, reducing the level of cushion within the rating, but avoiding downgrades.

One example of this is The Kroger Co., which repurchased $803 million of its shares in first-half 2011 compared with $228 million in first-half 2010. This will likely push leverage back toward 3x over the near term from 2.8x at midyear 2011, a level that is still commensurate with the company's 'BBB' rating.

Behind these more aggressive financial policies is the prevailing view that retailers can minimize their cost of capital at or around the 'BBB' rating level. Consistent with this is the fact that 11 of Fitch's 28 public ratings of U.S. retailers (39% of the total) are in the 'BBB' category. Adding to the risk of incremental debt-financed share buybacks is the fact that interest rates are so low that there is very little penalty in terms of borrowing costs or debt market access at the 'BBB' rating level versus the 'A' rating level.

For additional information, see "U.S. Retail 2012 Outlook," dated Nov. 22, 2011 on the Fitch Web site.

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