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Rating Action:

MOODY'S LOWERS ALL RATINGS OF FLEMING COMPANIES; OUTLOOK IS STABLE

07 Oct 2002
MOODY'S LOWERS ALL RATINGS OF FLEMING COMPANIES; OUTLOOK IS STABLE

Approximately $2.3 Billion of Debt Affected.

New York, October 07, 2002 -- Moody's Investors Service lowered all ratings of Fleming Companies, Inc. as follows:

$975 million secured credit facility to Ba3 from Ba2,

$355 million 10 1/8% senior notes (2008) to B2 from Ba3,

$200 million 9 ¼% senior notes (2010) to B2 from Ba3,

$400 million 10 5/8% senior subordinated notes (2007) to B3 from B2,

$150 million 5 ¼% convertible senior subordinated notes (2009) to B3 from B2,

$260 million 9 7/8% senior subordinated notes (2012) to B3 from B2,

Senior implied rating to B2 from Ba3, and the

Long-term issuer rating to B3 from B1.

The downgrade was prompted by our opinions that Fleming's national distribution presence does not provide the exceptional competitive advantage previously contemplated in our ratings and that the company's capital strength may be reduced with divestiture of its retail operations. The rating outlook is stable.

The ratings consider the company's debt protection measures relative to similarly rated credits, the possibility that retail assets with a book value of about $600 million will be sold for less than book value, and the uncertainty related to resolution of the Kmart bankruptcy. Directly, or indirectly through its customers, Fleming competes with respected retailers such as Wal-Mart (senior unsecured rating of Aa2), Target (senior unsecured rating of A2), and the national supermarket chains. Also impacting Moody's views of the risks facing Fleming are the intense competition within the fragmented distribution industry, the necessity to continually replace clients lost in the consolidating supermarket industry, and the challenges in effectively integrating actual and anticipated distribution acquisitions.

However, the ratings acknowledge the stability arising from Fleming's position as the only national grocery distributor, the potential leverage reduction resulting from divestiture of the retail segment, and the company's adequate liquidity, particularly given our expectation that the company will improve working capital efficiency to historical norms and use excess cash for balance sheet improvement. The ratings also recognize the company's efforts to diversify its wholesale customer base and its potential appeal to convenience store customers as the only national piece-pick distribution alternative to McLane (a unit of Wal-Mart).

The stable outlook reflects our belief that the current rating levels consider the likely outcomes to challenges facing the company over the next 18 months, including the expected divestiture of the retail division and the possible loss of additional Kmart business. Factors that could lead Moody's to consider a negative rating action include worse than expected affects from the Kmart situation, inability to replace the normal attrition of wholesale customers, or failure to effectively integrate new acquisitions. For Moody's to consider a positive rating action, the company would need to profitably diversify its wholesale revenue base and to materially grow operating cash flow through increased operating efficiencies. Moody's believes that meaningful operating improvement over the shorter term will be challenging, in spite of the company's important market presence and intention to sell the poorly performing retail division, given the industry-wide trend of weak supermarket sales over the last six months.

The Ba3 rating on the bank loan (comprised of a $550 million revolving credit facility and a $424 million term loan) recognizes the seniority of this debt relative to other parts of the capital structure. The accounts receivable and inventory of the company and its subsidiaries, as well as the equity shares and guarantees of all domestic operating subsidiaries, secure this loan with required collateral coverage to bank borrowings greater than 225%. Incurrence of additional debt requires pro-forma leverage greater than 3.0 times and senior leverage greater than 3.5 times. Moody's understands that proceeds from the sale of the retail segment will be used to pay down the term loan. As of July 13, 2002, about $330 million of the revolving bank facility remained available.

The B2 rating on the two issues of senior unsecured notes reflects the guarantees provided by the operating subsidiaries. However, the senior notes are effectively subordinate to the secured bank loan and rank equally with approximately $1.0 billion of trade accounts payable. The notching at the senior implied rating recognizes the restrictions on incurring additional secured debt.

The B3 rating on the three issues of senior subordinated notes considers that the notes are guaranteed by the operating subsidiaries but are contractually subordinated to substantial amounts of senior debt. The 2007 and 2012 indentures establish a fixed charge coverage test of 2.25 to 1 for the incurrence of additional debt, with revolving credit facility borrowings specifically carved out.

Adjusted debt (equals balance sheet debt plus 8 times gross rent expense) to EBITDAR of 5.6 times (based on reported results without adjustments) and fixed charge coverage of 1.6 times for the twelve months ending July 13, 2002 were weak relative to other sizable supermarket and food distribution companies. Wholesale operating margin of 3.1% over the last 12 months has modestly improved compared to previous periods as the company gained distribution efficiencies both from consolidating warehouses and adding volume. If the company realizes net proceeds of $450 million from divestiture of the retail division and maintains current operating efficiencies in spite of an expected wholesale loss of $800 million, then we estimate that adjusted leverage will decline to about 4.1 times and fixed charge coverage will increase to 1.9 times.

Divestiture of the remaining retail stores will complete Fleming's transition to operating a strictly wholesale business. In contrast with most other major grocery wholesalers that have expanded to derive a significant fraction of their revenue from supermarket operations, Fleming's retail segment has consistently fallen as a proportion of revenue. The July 2002 acquisitions of two convenience store distributors, Core-Mark in the West and Head in the Southeast, complemented Fleming's existing piece-pick distribution system and virtually completed the only nationwide piece-pick distribution network besides McLane. Moody's now understands that the company intends to devote a sizable proportion of future free cash flow to balance sheet improvement, instead of the previous plan to acquire more distribution companies and to build additional limited assortment retail stores. In Moody's view, the strategy to focus on organic growth through winning new wholesale accounts is prudent given the company's balance sheet.

Kmart, Fleming's single largest customer with 16% of wholesale revenue (pro-forma for the Core-Mark acquisition), has reported very weak performance every month since its January 2002 bankruptcy filing with substantial operating losses and comparable store sales declines. Kmart received bankruptcy court approval to initially close 283 stores (about 13% of Kmart's store count) in April 2002. Moody's expects that Fleming will only be modestly impacted from the closure of these generally low-volume stores. While Moody's believes that Kmart does not have a better substitute for Fleming's national grocery distribution capabilities, we believe that there is a reasonable possibility that more Kmart stores could be closed. Assuming sale of the retail division for $450 million, complete loss of the Kmart business, and small decreases in operating leverage as a result of lower distribution volume, then we estimate that adjusted leverage would be about 4.6 times and fixed charge coverage would remain at 1.6 times.

Fleming Companies, Inc., with principal executive offices in Lewisville, Texas, is a leading food distribution company serving approximately 3000 supermarkets (including 116 company-owned grocery stores), 40000 convenience stores, and 2000 other retail locations.

New York
Julia Turner
Managing Director
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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