A sell-side and buy-side analyst say it is time to begin reducing exposure to high-grade retailers, given the recent strong performance of the sector and the widespread belief that the economy is improving. However, they have differing views about which high-grade retailers should be taken off the table. A large East Coast buy-side firm has begun reducing exposure to high-grade retailers such as Albertson's Inc., Kroger Co. and Safeway Inc., primarily on the view that the names are too tight relative to the rest of the high-grade market. An analyst at the firm has expressed concern that these supermarket chains may take on more leverage a year or two down the road as they become increasingly acquisitive in order to stave off increasing competition from Wal-Mart Stores. Last Monday, the Safeway 6.5% notes of '11 (Baa2/BBB) were 100 basis points over Treasuries, the Kroger 6.8% notes of '11 (Baa3/BBB-) were 120 off the curve and the Albertson's 7.5% notes of '11 (Baa1/BBB+) were 105 off.
Dave Novosel, head of corporate bond research at Banc One Capital Markets, says that while he understands concerns about the tight spreads of supermarket bonds, he does not see any way for investors to pick up additional yield without significantly increasing credit risk. Novosel believes the retail sector on the whole will be a market performer. However, he suggests that investors looking to reduce exposure in the sector unload the bonds of May Department Stores. "While May Department Stores is very well-run, department stores are beginning to lose customers to some of the discount and specialty apparel retailers," he says. May's 8% notes of '12 (A2/A+) were 105 basis points over Treasuries last Monday.
Novosel also believes Target, and particularly Wal-Mart, may be five to 10 basis points overvalued. "While there's nothing wrong with the businesses, it's tough to get excited about these credits from a spread perspective. At a certain point you begin to bump up against absolute limits," he says. Wal-Mart's 6.875% notes of '09 (Aa2/AA) were 38 basis points over Treasuries last week, while Target's 6.35% notes of '11 (A2/A+) were 73 basis points wide of the curve.