March 20 - Overview -- U.S.-based grocery chain The Great Atlantic & Pacific Tea Co. Inc. (A&P) emerged from bankruptcy and closed on its exit financing, including a $270 million senior secured term loan and $490 million of debt and equity financing from an investor group. -- We are assigning a 'B-' corporate credit rating to the company and a 'B+' issue-level rating with a '1' recovery rating to the senior secured term loan. -- The negative outlook incorporates our belief that A&P may not improve operating profits such that it will be able to fund cash interest costs and needed capital spending on a sustained basis in the future. Rating Action On March 20, 2012, 2012, Standard & Poor's Ratings Services assigned a 'B-' corporate credit rating to Montvale, N.J.-based The Great Atlantic & Pacific Tea Co. Inc. (A&P). At the same time, we assigned a 'B+' issue-level rating (two notches above the corporate credit rating) and a '1' recovery rating to the company's $270 million senior secured term loan. The '1' recovery rating incorporates our expectation of very high (90% to 100%) recovery of principal in the event of a default by the company. The outlook is negative. Rationale The rating reflects our view that the company will maintain "adequate" liquidity (based on our criteria) in the near term and our belief that A&P has the potential to improve operating performance such that it will be able to sustain its postemergence capital structure. The view also incorporates our expectation that A&P can grow profits to fund cash interest and capital spending with operating cash flows. We believe that A&P lowered certain costs during its reorganization, and these efforts will improve the company's profitability in the near term. Despite these actions, we anticipate that A&P will still have weaker operating metrics than many industry peers. We also believe that A&P may also be susceptible to weak economic conditions and industry competition, and sales declines could offset the operational improvements. As a result of these factors, we assess the company's business risk profile as "vulnerable." We also view the company's financial risk as "highly leveraged," as a result of our forecasted credit ratios. Nonetheless, we realize that the company's relatively low cash interest burden provides the company some financial flexibility. We believe actions A&P has taken during its reorganization will benefit the company's operating performance during 2012. During its reorganization, A&P took actions to improve its cost structure considerably, including renegotiating its supply contract and reducing labor costs as a result of agreements with its various labor unions. We also expect A&P to receive more favorable terms with vendors upon emergence, which should lead to some gross margin enhancement. We believe the company's various initiatives to improve in-store execution, pricing, and merchandising should enhance sales and customer experience over time. Although these actions may lead to success in the future, we do not assume an immediate sales gain in 2012, and forecast relatively flat sales over the next year; however, we expect improvement thereafter. Below are our more detailed assumptions of the company's operating performance over the next two years, which is the basis for our ratings decision: -- Relatively flat sales in 2012 and a 2% to 3% increase in 2013, from higher comparable-store sales. -- Overall EBITDA margins to be moderately under 2% in 2012 and near 2.5% in 2013. -- This would lead to EBITDA of approximately $120 million in 2012 and about $180 million in 2013. This performance scenario would lead to the following credit ratios at the end of 2013 and cash flow dynamics over the next two years: -- We expect that the company will fund some of its capital spending with excess liquidity in 2012, and will be cash flow-neutral in 2013. -- At the end of 2013, adjusted debt to EBITDA will be in the mid-7x range. Our debt and adjusted debt include the company's first-lien term loan, second- and third-lien notes (we assumed that the second-lien notes will accumulate pay-in-kind interest over the next two years), the present value of operating lease commitments, a tax-adjusted self insurance liability, and an estimate of the company's multiemployer plan liability). -- Funds from operations (FFO) to adjusted debt of approximately 12%. These resulting ratios are in line with highly leveraged financial risk profiles. We believe that the total effect and timing of the company's various initiatives will likely be uneven and somewhat difficult to predict. As such, we believe that there is a wide range of possible performance scenarios and credit ratios over the next two years. Nonetheless, even in our most optimistic expected performance scenarios, we would expect the company's credit ratios to remain in line with indicative ratios of highly leveraged financial risk profiles. Conversely, in our anticipated downside scenarios, we still expect the company to have the liquidity resources to fund administrative costs and the capital spending associated with its operational initiatives over the next two years. Liquidity We view A&P's liquidity as adequate, and we forecast sources of liquidity to be greater than its uses over the next two years by a ratio of 1.2x. We expect sources to include $60 million to $70 million of excess cash, available borrowings on the company's $375 million revolving credit facility, and FFO in 2012 between $70 million and $80 million. We primarily expect cash uses to include working capital needs and capital spending in the range of $100 million to $135 million. Relevant aspects of A&P's liquidity, in our view, are as follows: -- We expect coverage of uses by sources to exceed 1.2x for the next two years. -- We expect that sources would exceed uses, even with a 15% drop in forecasted EBITDA. -- We anticipate that the company will have adequate headroom over maintenance financial covenants and the company will not have to comply with maintenance financial covenants over the next year. -- No near-term maturities or amortizations. Over the next year, we expect the company to use available liquidity sources to fund capital spending in 2012, but also believe that it could manage capital spending so that it is cash flow-neutral. In 2013 and beyond, we expect that the company will fund capital spending with cash flow from operations. The company may elect to pay cash interest on its second-lien notes if operating performance improves more than we anticipate. Thus, we do not expect the company to generate meaningful excess cash flow in the near or intermediate term. Recovery analysis For the complete recovery analysis, please see our recovery report on Great Atlantic & Pacific Tea Co. Inc., to be published as soon as possible following this report on RatingsDirect. Outlook The outlook is negative, indicating that we may lower the company's rating if it cannot generate sufficient cash to fund cash interest costs (of both its first-lien term loan and second-lien notes) and the necessary capital spending with operating cash flows in the near term. We believe that EBITDA needs to be in the range of $160 million to $190 million to successfully do so. Although there are several factors that could inhibit the company from reaching this level of profitability, we believe that if the company's sales trends are considerably negative in 2012 or flat or slightly negative throughout 2012 and into 2013, A&P won't reach that level of EBITDA. In either of those cases, we would likely lower our ratings. On the other hand, we would consider a stable outlook if EBITDA improved to the aforementioned range, and we were comfortable that the sales and operating trends would lead to a consistent performance. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List New Rating; Outlook Action To Great Atlantic & Pacific Tea Co. Inc. (The) Corporate Credit Rating B-/Negative/-- New Ratings Great Atlantic & Pacific Tea Co. Inc. (The) Senior Secured B+ Recovery Rating 1 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.