Fitch Ratings says that its recent downgrades of Lowe’s Companies, Inc. and Safeway, Inc., both a result of a more aggressive share repurchase posture, indicate a heightened risk that other US retailers may follow a similarly aggressive path.
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.
For additional information, see U.S. Retail 2012 Outlook
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