OREANDA-NEWS. Fitch Ratings has affirmed its 'B' Issuer Default Rating (IDR) on SUPERVALU Inc. (SVU). The Rating Outlook is Stable. A complete list of ratings is provided at the end of this release.

SVU's ratings are constrained by negative sales trends, declining operating income, a mediocre retail market position and long-term challenges within the retail and wholesale business, even though the company's leverage is low for the rating category. Such challenges include retailer consolidation, customer losses as the number of independent retailers decline, and heightened competition. Fitch projects total adjusted debt/EBITDAR will be the low-4.0x range in fiscal 2017 and the mid-4.0x range in fiscal 2018, up from 4.0x in fiscal 2016 with the inclusion of Save-A-Lot.

Ratings contemplate the potential separation of Save-A-Lot and Fitch's assumptions related to debt reduction and pro forma leverage (based on Fitch's fiscal 2017 forecast) under either a spin-off or sale scenario. If Save-A-Lot is spun off, we anticipate total adjusted debt/EBITDAR could increase to the high 4.0x range. Conversely, if Save-A-Lot is sold, Fitch anticipates total adjusted debt/EBITDAR will remain in the low 4.0x range. Fitch will evaluate SVU's post-separation capital structure and adjust issue-level credit and recovery ratings if necessary, but views the impact of a Save-A-Lot separation as neutral to SVU's IDR.

Scale with strong local market share positions and competitive pricing is what differentiates better-performing grocery retailers from operators like SVU which are currently losing market share. Meanwhile wholesale distributors could experience weaker pricing power and margin pressure as retailers continue to consolidate. SVU has not disclosed specific sales and operating income contributions from recent new wholesale wins but has indicated that the terms are different than with its smaller clients, as larger operators demand more from distributors.

KEY RATING DRIVERS

Weak Revenue, Earnings Trends:

SVU's revenue fell 3.9% to $5.2 billion in the first quarter ended June 18, 2016, after declining 1.6% to $17.5 billion in fiscal 2016 (February). Excluding the impact of the 53rdrd week in fiscal 2015, sales were essentially flat. Low - to mid-single-digit identical store sales (ID) sales declines at Save-A-Lot and retail, along with business losses and reduced revenue from existing clients in the wholesale segment are having a negative impact on revenue. Fitch projects EBITDA will decline nearly 10% to about $725 million, excluding stock option expense, in fiscal 2017. EBITDA declines should moderate in fiscal 2018 due to revenue growth but margin pressure could continue.

For SVU's retail segment, Fitch expects mid-single-digit ID sales declines for fiscal 2017. Gradual improvement should occur in fiscal 2018 due to price investments and improved store-level execution but Fitch expects SVU's retail banners will continue to be share donors over the long term. Gross margin contraction and operating earnings declines could continue absent significant cost reductions. Fitch projects segment EBITDA of about $200 million in fiscal 2017 from $248 million in fiscal 2016 and below $200 million in fiscal 2018.

For Save-A-Lot, assuming the business is not separated, Fitch expects low-single-digit ID sales declines for fiscal 2017 and improvement to 0% to 1% growth in fiscal 2018 due to a more normal inflationary environment. Segment EBITDA is projected to be approximately $200 million in fiscal 2017 with the potential to grow at a low-single-digit rate in fiscal 2018 due to new stores.

Fitch expects segment sales in wholesale to decline at a low single-digit rate in fiscal 2017 as revenue from new business, particularly from Marsh Supermarkets and The Fresh Market, start to materialize and along with the impact of customer losses. Absent additional customer losses, mid-single-digit sales growth is anticipated for fiscal 2018 as the full benefit of this new business is realized.

Wholesale segment EBITDA is projected to be approximately $270 million in fiscal 2017 and $300 million in fiscal 2018 but modest margin contraction is expected given the likelihood that larger-sized contracts come at a lower margin. SVU will have to offset what Fitch expects will be a 2%-3% attrition rate in its existing business with new business wins in order to maintain the revenue and EBITDA base in this segment.

Long-term Challenges for Wholesale and Retail Business

Based on Fitch's fiscal 2017 forecast, SVU's wholesale and retail segments will represent 63% and 37%, respectively, of the company's revenue and EBITDA post the separation of Save-A-Lot. Fitch recognizes SVU's focus on its wholesale operations and recent new business wins but expects the wholesale and retail operating environment to remain challenged longer term due to competitive pricing and consolidation and restructurings in the grocery industry. Excluding Save-A-Lot, Fitch projects EBITDA of about $530 million in fiscal 2017, down from $584 million in fiscal 2016. Fitch anticipates that EBITDA could decline to below $500 million, absent continued cost reductions, due to on-going revenue and margin pressure.

Save-A-Lot Separation Neutral to Ratings

Fitch views the separation of Save-A-Lot as neutral to SVU's credit profile, assuming debt reduction of about $350 million in the event of a spin-off and $750 million in the event of a sale. Fitch's assumptions reflect SVU's plan to capitalize Save-A-Lot with $400 million to $500 million of debt with net proceeds used to repay SVU's term loan. Assumptions also incorporate Fitch's view that Save-A-Lot would be valued at 6x-8x roughly $200 million of EBITDA if sold and that $750 million of debt repayment would be required per the company's credit facility.

Fitch projects pro forma total adjusted debt/EBITDAR (based on our fiscal 2017 forecasted debt and EBITDA) to be in the high-4x range with a spin-off and in the low 4x range or in line if Save-A-Lot is divested. Pro forma free cash flow (FCF) should remain positive, reflecting reduced interest expense and lower capex without Save-A-Lot. Ratings consider that a separation of Save-A-Lot would reduce or eliminate SVU's exposure to the hard discount channel, which has better longer-term prospects than SVU's retail and wholesale operations.

RECOVERY ANALYSIS

Fitch's ratings on individual debt issues are based on the IDR and the expected recovery in a distressed scenario. Fitch has allocated a distressed enterprise value of $2.6 billion (after administrative claims, and assuming Save-A-Lot is not spun off) across SVU's capital structure. Fitch arrived at this valuation by multiplying an assumed post-default EBITDA of approximately $530 million by a 4.9x multiple. The post-default EBITDA assumes an approximate 30% decline in consolidated EBITDA, while a blended multiple is used to incorporate Fitch's view of a going-concern multiple for each respective business segment. The blended multiple assumes 4.0x for the retail food segment, 4.5x for the independent business and 6.5x for Save-A-Lot.

The $1 billion revolving asset-backed loan (ABL) facility, which is assumed to be 70% drawn, is backed by inventories, receivables and prescription files, which Fitch collectively values at $1.3 billion. The $1.4 billion term loan is backed by real estate with a book value of $793 million and an estimated market value of $1 billion, and a pledge of the shares of Moran Foods, LLC (Save-A-Lot), which Fitch values at $1.3 billion, assuming a 6.5x multiple of EBITDA (net of allocated corporate expenses). As such, both facilities are assumed to receive a full recovery, leading to a rating on both facilities of 'BB/RR1'.

The senior unsecured notes are rated 'B/RR4', implying a 30%-50% recovery in a going-concern scenario. Fitch believes that in a liquidation scenario, SVU's company pension plan's underfunding of $545 million and multiemployer pension plan's underfunding of $597 million would rank ahead of the senior unsecured notes given the unique structural priorities available to the Pension Benefit Guarantee Corporation and pension plan fiduciaries. Therefore, in a liquidation scenario, there would be no recovery to the senior notes.

KEY ASSUMPTIONS

Fitch's base case fiscal-year key assumptions within the rating case for SVU on a status quo basis include:

--Revenue declines about 2% in 2017 due to sales declines in retail and wholesale, and then grows by roughly 5% in 2018 due mainly to revenue from new wins in the wholesale business;

--EBITDA declines nearly 10% in 2017 to $725 million with declines moderating in 2018 due to gradual improvement in ID sales and new wholesale business;

--FCF approximates $80 million in 2017 and $70 million 2018 assuming capex remains elevated to invest in the business;

--Total adjusted debt/EBITDAR approximates 4.3x in 2017 and 4.5x 2018.

Fitch's key assumptions assuming a separation of Save-A-Lot include:

--Consolidated revenue growth of 0% to down 1% assuming flat sales for wholesale beyond fiscal 2018 and low-single-digit declines at retail;

--EBITDA declines to below $500 million post separation due to margin pressure;

--FCF remains positive post separation;

--Debt paydown in the $350 million and $750 million range, depending on a spin-off or sale of Save-A-Lot;

--Pro forma total adjusted debt/EBITDAR is in the low-4.0x to high-4.0x range, depending on a spin-off or sale of Save-A-Lot.

RATING SENSITIVITIES

Absent a separation of Save-A-Lot, future developments that may, individually or collectively, lead to an upgrade to 'B+' include improved top line performance across each of SVU's businesses. Ratings would balance the growth potential of Save-A-Lot with long-term challenges in the retail and wholesale business.

Assuming a separation of Save-A-Lot, future developments that may, individually or collectively, lead to an upgrade include stable market share trends; total adjusted debt/EBITDA sustained below 4.0x; relatively stable margins; and positive FCF.

Future developments that may, individually or collectively, lead to a downgrade include consistently weak top line performance across each of the company's businesses and margin contraction that lead to negligible or negative FCF.

LIQUIDITY

SVU's liquidity is adequate and is supported by a $1 billion ABL credit facility, with a borrowing base management estimates will range from $900 million to $1 billion. SVU had $744 million available credit on its ABL at June 18, 2016. Absent a separation of Save-A-Lot, Fitch projects FCF of $70 million-$80 million annually over the next two years. Significant upcoming maturities are limited to $1.4 billion of term loans due March 2019. Fitch expects FCF would remain positive following a separation of Save-A-Lot business.

Fitch currently has the following ratings:

SUPERVALU INC.

--IDR at 'B';

--$1 billion secured revolving credit facility at 'BB/RR1';

--$1.4 billion secured term loan at 'BB/RR1';

--$750 million senior unsecured notes at 'B/RR4'.

The Rating Outlook is Stable.