OREANDA-NEWS. Fitch Ratings has assigned a rating of 'BBB' to The Kroger Co.'s (Kroger) multi-tranche $1.1 billion debt issuance. The notes rank pari passu with existing debt and are being issued under Kroger's indenture dated June 25, 1999. Proceeds from the issuance will be used in part to refinance the debt used to fund the acquisition of Roundy's, Inc., which closed Dec. 18, 2015. The Rating Outlook is Stable. A full list of ratings is shown below.

KEY RATING DRIVERS

Industry-Leading ID Sales: Kroger generates industry-leading non-fuel identical store (ID) sales growth, which has led to market share gains in most of its major markets. Non-fuel ID sales have been positive for 12 consecutive years and have accelerated in recent periods due mainly to an increase in customer visits. ID sales increased 5.5% during the three quarters ended Nov. 7, 2015, after rising 5.2% in 2014, 3.6% in 2013, and 3.5% in 2012.

Growth has been due to positive pricing perception by customers, effective marketing through use of loyalty card data, and improvements to the shopping experience. Fitch expects Kroger will maintain low- to mid-single-digit ID sales growth of 3% - 4% over the next 24-36 months.

Relatively Stable-to-Improving EBIT Margins: After trending lower for several years due to investments in price, Kroger's gross margin is currently benefitting from the decline in fuel prices and reductions in transportation and advertising costs.

Kroger has successfully offset long-term gross margin pressure with cost-containment and the leveraging of fixed costs, enabling gradual EBIT margin expansion from 2.8% in 2012 to 3.0% in 2014 and 3.2% for the first three quarters of 2015. Fitch anticipates Kroger's EBIT margin could decline slightly but remain above 3% following the acquisition of Roundy's, which had an EBIT margin of 1.3% in 2014 and will require significant price investments to increase competitiveness.

Higher Capex to Support Growth: Kroger has stepped up its new store growth to support its long-term earnings per share growth target of 8%-11%. Capex is projected to slightly exceed $3.3 billion in 2015, up from $2.8 billion in 2014, to support high-return projects and faster store growth in its existing and high-potential markets for fill-in opportunities. Kroger expects to increase capex by at least $200 million annually over the next several years, implying capex could be north of $3.5 billion in 2016.

Cash Flow Usage, Healthy FCF: Kroger has utilized its cash to invest in its business, repurchase shares, and to fund its dividend. Annual free cash flow (FCF) is forecast to be approximately nearly $600 million in 2015 and roughly $400 million in 2016 after taking into consideration increases in capex and modest dividend growth. Kroger reviews its dividend yearly but the payout to net income has been approximately20% in recent years.

Steady Leverage: Adjusted debt/EBITDAR declined to 2.6x at the LTM period ended Nov. 7, 2015 from 3.3x at year-end 2013 (post the Harris Teeter Supermarkets, Inc. acquisition). Leverage is expected to remain within the company's targeted range of 2.0x - 2.2x net debt/EBITDA, which equates to adjusted debt/EBITDAR of below 3.0x, following closure of the Roundy's acquisition. Debt reduction is not anticipated as management is expected to direct essentially all its FCF after dividends to share repurchases.

Scale, Diversity Are Benefits: Kroger benefits from its position as the largest supermarket retailer in the nation, its geographic diversity, and its multiple store formats which provide convenience to its customers. Kroger generates over $100 billion of revenue, and operated 2,625 supermarket and multidepartment stores, 782 convenience stores, and 326 jewelry stores across 49 major markets in 2014. The company generally holds the No. 1 or No. 2 position in those markets. Kroger has a significant fuel business, and manufactures about 40% of the private-label products sold in its stores. Corporate brands represent about 25% of total units sold, excluding fuel and pharmacy.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Kroger include:

--Low-single-digit organic revenue growth in 2015, due mainly to lower retail fuel prices, and then mid-single-digit growth thereafter driven primarily by supermarket ID sales. The acquisition of Roundy's is expected to add about $4 billion of annual revenue, or a 4% contribution, in 2016.

--Non-fuel ID sales approximating 5% in 2015 and 3.5% - 4% annually thereafter.

--EBIT margin remains above 3% over the next several years, even after the acquisition of Roundy's, as cost reduction efforts help fund investments in price. EBITDA margin remains above 5%.

--FCF (post dividends) of nearly $600 million in 2015 and roughly $400 million in 2016, reflecting increases in capex and modest dividend growth.

--Net debt/EBITDA remains within management's targeted 2.0x - 2.2x range, approximating adjusted debt/EBITDAR of 3.0x throughout the forecast period with debt increasing and proceeds used for share repurchases or tuck-in acquisitions.

RATING SENSITIVITIES
A positive rating action would be considered if adjusted leverage improved to the mid-2x range, together with steady mid-single-digit ID sales growth and gradual margin improvement. This is not anticipated at this time.

A negative action would be considered if adjusted leverage moved up to the low 3x range due to pressure on margins and/or a more aggressive approach to share repurchases or acquisitions.

LIQUIDITY

Kroger had approximately $2.6 billion of liquidity at Nov. 7, 2015, of which approximately $1.2 billion was cash and the remainder was availability on the firm's $2.75 billion revolver. Ongoing liquidity is supported by the company's FCF, which Fitch projects will be approximately $400 million in 2016. Kroger's revolving credit facility expires in June 2019 and supports commercial paper (CP) borrowings and letters of credit (LCs). The revolver subjects Kroger to a maximum net debt/EBITDA financial maintenance covenant of 3.5x. The company's 2.0x - 2.2x leverage target results in significant covenant cushion. Kroger had no outstanding borrowings on its revolver but had $1.4 billion of CP and $13 million of LCs under the credit facility at Nov. 7, 2015.

FULL LIST OF RATING ACTIONS

Fitch currently rates Kroger as follows:

--Long-term IDR 'BBB';
--Senior unsecured notes 'BBB';
--Bank credit facility 'BBB';
--Short-term IDR 'F2';
--Commercial paper 'F2'.

The Rating Outlook is Stable.