OREANDA-NEWS. Fitch Ratings has affirmed US and European food retailer Ahold Delhaize NV's Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB' following the completion of the merger of Royal Ahold NV (Ahold) and Delhaize Group SA (Delhaize) at the end of July 2016. The Outlook is Stable.

The rating reflects the combined group's improved market position and scale with 2015 pro-forma revenues of EUR62.6bn and EBIT of EUR2.2bn, trading from nearly 6,500 stores in 11 countries. It will be the fifth-largest food retail group in the US with strong representation on the East Coast and well-respected local brands, while remaining a market leader in the Netherlands and Belgium. The merger is a defensive move, but it puts the enlarged group in a stronger position to survive in a competitive and consolidating food retail environment in the US and Europe. This underpins the Stable Outlook.

The group has received regulatory clearance from the US Federal Trade Commission (FTC) and the relevant Dutch and Belgian authorities. The FTC clearance was given further to the merged group's US subsidiaries agreeing to dispose of 81 stores in a limited number of locations in which the two US subsidiaries both operate. These stores represented around only 3% of Ahold-Delhaize's 2015 US revenue. The EUR500m of cost savings identified should also give the group some flexibility on pricing, capex or debt reduction. We believe the merger will entail moderate integration risks, particularly in the US where two large operations will have to be integrated, although we believe this should be manageable.

The merger was funded entirely by a share issue of new Ahold Delhaize shares and no new debt. Consequently, leverage will remain stable compared with Ahold on a standalone basis, and we estimate funds from operations (FFO) lease adjusted net leverage of around 2.9x-3.0x post-merger, comfortable for the 'BBB' relative to sector rated peers.

KEY RATING DRIVERS

Affirmation on Merger

The affirmation at 'BBB' reflects Ahold Delhaize's stronger business risk profile relative to each of Royal Ahold N. V. and Delhaize Group on a standalone basis. The new combined Ahold Delhaize will benefit from greater scale and diversification in its activities in the US and Europe. Management has announced EUR500m synergies, which Fitch believes are achievable (even though we conservatively assume up to EUR400m in our rating case forecasts) and should enable it to better withstand strong competition in its core markets.

Moreover Fitch forecasts no significant deterioration in financial metrics from Ahold's current levels as a result of the merger due to the all-share nature of the transaction. This also supports our affirmation of the IDR and senior unsecured rating.

Greater Scale

Ahold Delhaize will have enhanced scale with a turnover of over EUR66bn and 6,500 stores in Europe and the US. The combined group will be the fifth-largest food retailer in the US and enjoy slightly better geographical diversification with operations in 11 countries. A strong market position and scale places Ahold Delhaize strongly in the 'BBB' rating category. It will also have critical size in the US, which should lead to some improved purchasing power. The group should also eventually benefit from a more cost-efficient distribution network in its US operations.

Stronger US Presence

The combination of Ahold and Delhaize in the US is beneficial from a credit perspective in a retail market characterised by consumers' shift to online sales and fierce competition leading to deflation and consolidation, as seen in the tie-ups between Safeway and Albertsons, and Roundy's and the Kroger Company (BBB/Stable). The success of the merger will depend on their ability to integrate their US operations, which accounted for a large proportion (68%) of combined operating profit in 2015.

Business Transformation, Operating Margin

Ahold's EBIT margin erosion stopped in 2015 and stabilised at 3.8%, above the average for other European food retailers. The announced cost savings should cover most of the investments initiated by management (such as online development and better product offering) after the merger in 2016 and 2017 to adapt Ahold Delhaize to the new realities in its core markets.

Fitch also considers management's cost savings target of EUR500m as realistic while improved purchasing should underpin operating margins in a challenging environment, thereby avoiding any meaningful margin sacrifices. Cost savings are likely to continue being reinvested, while low like-for-like sales growth in stores and fast-growing online sales are likely to enable only limited benefits from operating leverage. As a result we expect the merger to slightly enhance profitability over the medium term, with EBIT margin up to 4.0%-4.1% by 2019.

Healthy Free Cash Flow

Fitch expects Ahold Delhaize to keep on generating strong free cash flow (FCF) over FY16-FY19 through improving operating margins, averaging 1.4% of sales per year, with only small bolt-on acquisitions in the next three years as the two entities integrate. This also reflects Fitch's forecast of controlled capex growing to around 2.5% of revenues by 2017 and remaining stable thereafter.

Financial Flexibility, Leverage

Fitch expects the enlarged group's financial structure and flexibility to remain consistent with a 'BBB' financial profile, with estimated adjusted FFO net leverage around 3.0x at end-FY16 and a solid financial flexibility particularly given the group's well staggered debt maturity profile. This is aligned with the group's commitment to maintaining an investment grade rating, which further underpins the affirmation.

In the absence of any unforeseen extraordinary shareholder distributions, our forecast of leverage trending below 3.0x beyond 2017 remains strong for the 'BBB' IDR. Moreover strong post-merger cash flow generation in 2016 should also negate the EUR1bn special dividend paid during 1H16 by Ahold to its own shareholders before the merger date. While the merged company has made no announcement in respect of possible future special dividend payments, depending on their size, this may limit financial headroom.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

-Low single-digit organic sales growth in both the European and US operations.

- Up to EUR400m of sustainable cost savings to be progressively realised in the three years following merger completion partly reinvested in the business.

- Slight EBIT margin contraction in FY16 to 3.6% (FY15: 3.7% pro forma the merger), back to around 4% by end-2018 as synergies are progressively achieved.

- FCF margin averaging between 1.0% and 1.6% in the four years following merger completion, partly tempered by expected capex, and restructuring costs.

- EUR400m one-off restructuring/ integration costs spread between 2016 and 2017.

- EUR1bn capital return to Ahold shareholders in 1H16 and a moderate increase in dividend payouts in 2016 and 2017.

RATING SENSITIVITIES

Positive Future developments that may, individually or collectively, lead to positive rating action include:

- Positive like for like sales growth in core markets leading to sustained gains in market shares, combined with steady EBIT margin and a successful integration in the US and Holland/Belgium, which represent the core of the group's sales and profits.

- FFO fixed charge cover above 3.0x.

- FCF margin of at least 2% on a sustained basis.

- Lease-adjusted FFO net leverage sustainably below 3.0x.

Negative Future developments that may, individually or collectively, lead to negative rating action include:

- EBIT margin falling consistently below 3.5%, due to intense competition in core markets or linked to any meaningful disruption created during the integration process.

- FFO fixed charge cover falling below 2.5x.

- Neutral or mildly negative FCF.

- Lease-adjusted FFO net leverage trending towards 4.0x driven by either sustained operating underperformance or a more aggressive financial policy post-merger.

LIQUIDITY

As of 1 August 2016 we estimate Ahold Delhaize benefited from an undrawn committed credit facility of EUR1.0bn due 2021 and Fitch's estimated available unrestricted cash in excess of EUR2bn. The group's debt maturity profile is also comfortable with limited debt maturities within the next four years given an average pro forma debt maturity between eight and nine years at end-2015.