By Marshall Hargrave
SuperValu (SVU) might well be one of the most undervalued grocers in the business. The grocer's most notable hedge fund investor is Maverick Capital, which increased its stake by over 1000% during 3Q 2012. Maverick now owns roughly 4% of the retailer. Big-name private equity firms have also been fawning over the grocer. Other notable PE firms taking a stab at the retailer include KKR and TPG Capital, but Cerberus Capital has taken the lead. Billionaires Jim Simons and Ken Griffin are both big-name investors owning SuperValu (check out Jim Simons' big bets).
Recent news suggests that a deal between Cerberus and SuperValu is imminent. Cerberus plans to only acquire parts of SuperValu, then take equity in the rest. The key parts of the deal are speculated to include the purchase of SuperValu's Albertsons and Save-A-Lot chains by injecting $500 million into the grocer. The relationship between SuperValu and Cerberus goes beyond the recent announcement -- SuperValu took part in the 2006 breakup of Albertsons' grocery stores, where SuperValu got 1124 stores and Cerberus received 650. The Cerberus purchase likely involves motives to merge SuperValu's Albertsons stores with its own.
SuperValu is still down almost 65% over the last twelve months -- trading at a $625 million market value and below $3 per share -- but we believe there could still be great value hidden in the company. SuperValu has nearly 1,100 supermarkets and 64 million square feet of retail space. Of all this retail space, the grocer owns around 40% or 25.6 million square feet.
Looking at its real estate portfolio -- in a back of the envelope calculation, the average lease rate for the 38.4 million square feet leased by SuperValu is somewhere around $7.50 per square foot -- based on capital structure and the most recent cash flow from financing activities.
The long-term historical average capitalization rate of 7% applied to the square footage rate puts a theoretical value on the leased properties at $107 per square foot. This means the 25.6 million square feet owned by SuperValu could hold upwards of $2.7 billion in value. The retailer saw TTM sales of $35 billion, and even with a $2.7 billion market value (based on the real estate portfolio), the company would still only trade at 0.08x sales.
Revenues in FY2013 (fiscal year end February) are expected to be down 4% on the back of a 4% decrease in same store sales. On top of this, FY2013 EPS is expected to come in at $0.40, down from $1.24 in FY2012.
One of SuperValu's initiatives for turning around sales and earnings includes putting under-performing stores and properties to work by closing certain supermarkets and replacing them with more stable tenants. As a part of this strategy, in September 2012, Supervalu closed down 60 of its under-performing stores. Other initiatives include new store development and new merchandise in stores, not to mention the rehab of 100 stores in fiscal 2013. Cost-reduction initiatives include a planned $250 million reduction in administrative and operational expense before FY2014.
Key turnaround efforts include improving its balance sheet with cash generation and debt reduction. SuperValu expects to pay out only $400 million in capital lease and debt payments in 2013 and 2014. Meanwhile, the grocer did manage to generate over $2.2 billion in operating cash flow over the trailing twelve months.
From a valuation standpoint, SuperValu trades at one of the cheapest P/E ratios around, with a forward P/E of 6x -- compared to other grocers such as Kroger Co. (KR) (10x) and Safeway Inc. (SWY) (9x). The retailer also trades at an EV/EBITDA multiple of 4x, with a historical average of 5x.
Both the struggling grocers, SuperValu and Safeway, have heavy debt loads compared to their peers. SuperValu has a debt ratio of 50% and Safeway is at 45%, compared to Kroger's 35%. SuperValu's long-term debt includes $6 billion, but the grocer has $150 million in cash, $750 million in receivables and $2.2 billion in inventory -- a total of $3.2 billion. Margins have been in decline for Safeway, which saw its FY2010 operating margins fall from 2.8% to 2.6% the next year, while SuperValu went from 2.3% (FY2010) to 2.6% (FY2011).
Safeway expects sales to be up 3% in 2013, but food inflation and rising gasoline prices will put a strain on margins. Longer-term concerns relate to the entry of new competitors into the grocery market, but Safeway has been holding market share with its low-cost product offerings. Safeway also had Bridgewater's Ray Dalio as a top investor, not to mention fellow billionaire Ken Griffin (check out Ken Griffin's big bets).
Kroger, meanwhile, is one SuperValu's most notable competitors, and has also felt the pressures from Wal-Mart (WMT) and new organic grocers. Helping to give some diversity to Kroger over the likes of Wal-Mart includes such segments as bakery and floral.
The two organic grocers stealing market share from conventional grocery retailers include Whole Foods Market Inc. (WFM) and The Fresh Market Inc (TFM). Whole Foods pays a 0.9% dividend yield, and the Fresh Market is up 45% since its late-2010 IPO, whereas the Dow Jones Industrial Average is up only 17%. Billionaire Steve Cohen of SAC Capital upped his stake in Whole Foods by over 1000% last quarter (check out Steve Cohen's top picks).
These two organic foods companies also have the best expected growth, with long-term EPS expected growth rates of 17% (Whole Foods) and 23% (Fresh Market) -- namely expected to be driven by increased demand for healthier foods. Whole Foods expects some of the more robust growth at 11% for FY2013, on the back of square footage growth of 8.0%.
To recap: SuperValu appears to be trading at a value ($625 million) that could be well below its real estate value. The grocer owns 40% of its supermarket locations, and the suggested value of its real estate portfolio could be upwards of $2.5 billion. Although its debt levels are high at $6 billion, the grocer is generating cash flow ($2.2 billion operating cash flow in TTM) in excess of its debt and lease obligations ($500 million expected FY2013).