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Rating Action:

MOODY'S CONCLUDES REVIEW OF GREAT ATLANTIC & PACIFIC TEA CO. BY LOWERING ALL RATINGS ; OUTLOOK IS NEGATIVE

31 Oct 2002
MOODY'S CONCLUDES REVIEW OF GREAT ATLANTIC & PACIFIC TEA CO. BY LOWERING ALL RATINGS ; OUTLOOK IS NEGATIVE

Approximately $1.2 Billion of Debt Affected.

New York, October 31, 2002 -- Moody's Investors Service lowered all ratings of The Great Atlantic & Pacific Tea Company, Inc ("A&P") as follows:

$425 million secured revolving credit facility to Ba3 from Ba2,

$ 22 million of 7.70% senior notes (2004) to B3 from B2,

$242 million of 7.75% senior notes (2007) to B3 from B2,

$275 million of 9.125% senior notes (2011) to B3 from B2,

$200 million of 9.375% senior notes (2039) to B3 from B2,

Senior unsecured shelf to P(B3) from P(B2),

Subordinated shelf to P(Caa1) from P(B3),

Junior subordinated shelf to P(Caa1) from P(B3),

Preferred stock shelf to P(Caa2) from P(Caa1),

Preferred trust securities issued by A&P Finance I, A&P Finance II, and A&P Finance III to P(Caa1) from P(B3),

Senior implied rating to B2 from B1, and the

Long term issuer rating to B3 from B2.

In spite of our opinion that the company has a reasonable amount of liquidity at least for the intermediate term, the downgrade was prompted by the long-term decline in the company's competitive position, inability to make progress at improving weak operating margins, and the continued negative free cash flow. The rating outlook is negative. This concludes the review that commenced on August 5, 2002.

The ratings consider the company's leveraged financial condition, substandard operating margins (in spite of the relatively high gross margins), and the competitive nature of the supermarket industry. The weak return on assets, which causes us to conclude that additional asset rationalization may be necessary, and the historical inability to improve operations or the balance sheet, in spite of strategy and management changes, are also reflected in the ratings. Difficulties in achieving operating synergies (partially caused by the widely scattered markets in which the company operates) and the need to use a significant proportion of expected free cash flow for store upgrades and information technology investments also impact the ratings.

However, the relatively high gross margins (resulting from high perimeter department sales), the company's decent liquidity position, and incremental improvements in working capital efficiency benefit the company. The ratings also recognize that the company has the #1 or #2 position in its four most important markets (Detroit, New Orleans, the New York Metro area, and Toronto),

The negative outlook considers the possibility that ratings may decline if the regions outside of Ontario and New York do not meaningfully contribute, overall results are further affected by the heavy promotional activity around New York, or return on assets does not improve. While the company currently has decent liquidity, the necessity to make significant additional drawings on the credit facility would impact Moody's view of the risks facing the company. Besides a sustained improvement in leverage, substantial improvements towards industry operating norms will be important to progress up the rating scale.

The Ba3 rating on the secured revolving credit facility ($340 million available to The Great Atlantic and Tea Company, Inc. and $85 million available to The Great Atlantic & Pacific Company of Canada) considers that this debt, besides enjoying guarantees of the company's operating subsidiaries, is secured by a borrowing base comprised of inventory and owned real estate. The March 2002 amendment extended the maturity date to June 2005 and the October 2002 amendment relaxed the covenant for minimum fixed charge coverage. Moody's believes that the lenders are well protected by collateral value and the structure of the facility. We expect that much of the credit facility will remain undrawn even during seasonal inventory peaks. Moody's observes that the company had cash on hand of $146 million and revolving credit availability of $255 million on September 7, 2002 and, with the most recent amendment, likely will remain in compliance with all bank agreement covenants over the medium term.

The B3 rating on the unsecured notes considers that this debt is issued at the holding company level and does not receive guarantees from the operating subsidiaries. These unsecured notes are effectively subordinate to significant operating company obligations including the bank facility and trade accounts payable. Except for the relatively small issue due in 2004, none of the company's bonds mature before 2007.

Moody's believes that A&P's gross margins of 28.5% in the first 28 weeks of Fiscal 2003 were better than the supermarket industry average, even though margins declined slightly from 28.8% in the same period of Fiscal 2002 as supermarket marketing efforts intensified (particularly around the New York Metro area). However, operating margins are low, even for the low-margin supermarket industry. In Moody's view, the company enjoys high gross margins due to the relatively high proportion of perimeter department sales (ie. bakery, deli, seafood) but operating margins fall below industry norms because of sizable fixed costs (ie. labor) for many low-volume stores.

Calculations for the company's debt protection measures can significantly vary, according to the treatment of special charges. In general, Moody's considers the special charges at A&P to be an ongoing cost of doing business since they have occurred every year for several years and, in our opinion, circumstances may require additional special charges in future periods. The company has taken about $644 million in operating special charges over the past 4 1/2 years (slightly offset by $61 million in extraordinary demutualization income). If special charges and extraordinary income are not considered part of operating cash flow, lease adjusted leverage has trended over the past several years to 7.2 times in September 2002 from 4.0 times in February 1998. Going forward, Moody's expects that the company's business plan for a relatively modest program of new stores and major remodels will require the reinvestment of virtually all cash flow from operations.

The company operates in several different regions of North America. The regions around Detroit, New Orleans, Toronto, and the New York Metro area provide about 80% of the company's revenues, while almost all operating profit has historically come from the New York Metro and Toronto regions. Over the past several quarters as the economic slowdown has impacted several industries important to the New York Metro economy, grocery retailer promotional activity has impacted A&P's margins and cash flow. With four New York Metro area competitors having similar market shares (ShopRite, A&P, Pathmark (senior implied Ba3), and Stop & Shop (senior unsecured of parent Ahold Baa1)), we expect that promotional activities designed to maintain customer appeal will remain unusually intense even for the highly competitive supermarket industry.

The Great Atlantic & Pacific Tea Company, Inc., headquartered in Montvale, New Jersey, operates 692 supermarkets in 15 states, the District of Columbia, and Ontario under the following trade names: A&P, Waldbaum's, The Food Emporium, Super Foodmart, Super Fresh, Farmer Jack, Kohl's, Sav-A-Center, Dominion, The Barn Markets, Food Basics, and Ultra Food & Drug. The parent of the German supermarket operator Tengelmann owns 57% of A&P.

New York
Andris G. Kalnins
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Richard Baldwin
Asst Vice President - Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.

​
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