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Rating Action:

MOODY'S LOWERS SR SUB NOTES OF INGLES MARKETS TO B3

28 Apr 2005
MOODY'S LOWERS SR SUB NOTES OF INGLES MARKETS TO B3

Approximately $350 Million of Debt Securities Affected

New York, April 28, 2005 -- Moody's Investors Service downgraded all ratings of Ingles Markets Inc ("Ingles") including the 8.875% senior subordinated notes (2011) to B3 from Ba3. The downgrade reflects the expectation that credit metrics and free cash flow generation will remain significantly weaker than Moody's had anticipated as capital investment and dividends consume most operating cash flow, ongoing reliance on bilateral lines of credit, and the increasing challenges for conventional supermarket operators. The recent restatement of financial results for the 2004, 2003, and 2002 fiscal years did not adversely affect Moody's credit opinion. The rating outlook is stable. This rating action concludes the review that commenced on January 21, 2005.

Ratings lowered are as follows:

• $350 million of 8.875% Senior Subordinated Notes (2011) to B3 from Ba3,

• Senior implied rating to B1 from Ba2, and the

• Long-term unsecured issuer rating to B2 from Ba3.

Moody's does not rate any of the secured or unsecured bank debt.

Debt protection measures are meaningfully weaker than Moody's expected at this point when ratings were initially assigned in November 2001. Moody's had anticipated a more conservative allocation of operating cash flow between debt reduction, dividends, and capital investment so lease adjusted leverage was now expected to come close to 4 times and fixed charge coverage would approach 2 times. In spite of good operating performance in recent years, free cash flow has generally been negative and leverage has remained relatively high due to substantial cash outflows for real estate purchases and dividends. For the twelve months ending December 2004, lease adjusted leverage equaled around 5 times (based on gross rent without netting out subrental income) and fixed charge coverage was about 1.5 times. Given the company's real estate policy and financial strategy, Moody's expects balance sheet improvement from free cash flow to remain modest over the medium-term. Although the company makes significant ongoing investments in its store base, enjoys a solid share of its local markets, and consistently has an EBITDAR margin greater than 8%, it faces increased competition as larger traditional and non-traditional grocery retailers continue opening stores. While Ingles has sufficient external sources of finance in the form of bilateral lines of credit, a committed syndicated bank loan facility would be more typical for a company with revenue in excess of $2 billion.

Constraining the ratings are the limited cash flow available for balance sheet improvement because of the strategies of owning most real estate and having a high dividend payout ratio, the potential uncertainty of relying on bilateral lines of credit in a hypothetical distress scenario, and the substantial competitive challenges that the company faces. Moody's believes that the high level of competition from supercenters, other non-traditional grocery retailers, and other conventional supermarket operators such as Kroger (senior unsecured Baa2), Publix (unrated), Bi-Lo (unrated), Food Lion (senior implied rating of parent Delhaize America Ba1), and Wal-Mart (senior unsecured rating Aa2) will challenge the company's ability to grow cash flow and reduce capital investment. Debt protection measures that are significantly weaker than Moody's had expected at this point following the initial rating assignment in November 2001 and the exposure to economic conditions within a relatively small geographic region (primarily the western halves of the Carolinas plus adjacent areas of neighboring states) also negatively affect Moody's opinion of Ingles.

However, credit strengths are the potential medium-term liquidity from the company's large real estate portfolio given that unencumbered asset fair market value meaningfully exceeds book value, Moody's expectation that the long-term stability of operating strategy will continue during the ongoing transition to a second generation of management and ownership, and the company's important position in an economically vibrant region. Moody's confidence that Ingles should be able to maintain solid operating margins and a strong market position, even as competitors continue opening stores in line with the growing regional population, also support the ratings.

The stable rating outlook reflects our expectation that (1) operating performance and market share will remain near current levels, (2) returns to shareholders will not increase from current levels, and (3) asset fair market valuation will remain strong relative to total debt commitments. If cash outflows for dividends and capital investment prompt leverage increases, the current level of operating performance falters, or returns on capital investment fall below expectations, then the ratings would be adjusted downward. Over the longer term, an upgrade would require meaningfully positive free cash flow generation, improved debt protection measures (such as fixed charge coverage comfortably exceeding 2 times and lease adjusted leverage falling well below 5 times), a strong liquidity profile that includes a committed syndicated bank loan facility, and continued profitable share of its local markets.

The B3 rating on the senior subordinated notes considers that this debt is contractually subordinated to significant amounts of more senior obligations. Ingles Markets, Inc, which directly runs all material operations except for the non-guarantor dairy subsidiary, is the note issuer. The more senior claims are principally comprised of $246 million of mortgages and other secured debt, five bilateral unsecured credit lines totaling $135 million, and $157 million of accounts payable. Given that about half of the company's real estate is unencumbered and our belief that real estate fair market value substantially exceeds book value, Moody's expects that this subordinated debt class has a good level of protection in a distress scenario.

Ingles Markets, Inc, with headquarters in Asheville, North Carolina, operates 197 supermarkets principally in North Carolina, South Carolina, Georgia, and Tennessee. Revenue for the four quarters ending December 2004 was almost $2.2 billion.

New York
Angela Jameson
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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