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By Siraj Sarwar

Recently, Supervalu (SVU) announced an agreement for the sale of five retail grocery banners to AB Acquisition LLC, an affiliate of a Cerberus Capital Management-led investor consortium. As per the agreement, it will sell 877 stores from Albertsons, Acme, Jewel-Osco, Shaw's, and Star Market stores as well as related Osco and Sav-on in-store pharmacies to AB Acquisition LLC. Supervalu will receive $3.3 billion to reduce its debt by selling five of its supermarket chains. The new sale deed will provide a lifeline for Supervalu, as it has more than $6 billion in long-term debt and capital lease obligations. In this article, I will look at the announced deal and the company's future business prospects.

Background

Supervalu is going through a tough period. The company is experiencing intense competition from several competitors such as Wal-Mart (WMT), Safe Way (SWY), and Kroger (KRG). Supervalu's revenues keep going down and the profit margins keep shrinking. Supervalu's cash flows were in a bad condition. Until recently, the company was almost out of cash.

Supervalu was close to insolvency due to the massive debt of $6.4 billion. The company was paying an enormous amount of interest. The complex and high-cost business model also led the company to post losses quarter after quarter. Other low-price retailers are supplying food at reasonable prices to attract customers. In contrast, traditional grocers such as Supervalu have relatively higher labor costs, which make it difficult to keep up with the competition.

The recent sale deed will hopefully help the company to better position itself. Supervalu has announced a definitive agreement to sell 877 units to an investment group led by Cerberus Capital. As a result of this agreement, Supervalu will receive $100 million in cash and get rid of $3.2 billion of debt obligations. However, Supervalu will still remain as a publicly traded company. The new Supervalu will have its Save-A-Lot stores, wholesale distribution business, and some local supermarket chains. In addition, Supervalu will receive an additional investment from Cerberus Group.

Is It a Win-Win Deal for Supervalu?

Originally, Supervalu wished to sell the entire business, but financing troubles kept that from taking place. The sale transaction of 877 stores will close at the end of March. I believe the transaction will be a good one for Supervalu. Presently, the company's financial situation is not desirable. Investors experienced significant losses. The company's balance sheet seriously needs liquid assets to avoid insolvency.

Supervalu needs a mass of money to get a balance between liabilities and assets. I believe the sale deed will fill that space in its balance sheet. Let's take a deeper look at the company's financial position.

Figures in Millions

Revenue in Q3 of 2013

Revenue in Q3 of 2012

Retail Food

$16,982

$18,297

Sav-A-Lot

$3,226

$3,236

Independent business

$6,334

$6,336

Source: Q3 Report.

The new company will keep its Save-A-Lot and other independent stores. As the above table demonstrates, Supervalu posted better results from these stores. At the end of Q3, Supervalu sales from independent business and Save-a-Lot segment grew by a small percentage. After the sale deal, the company's operational burden will also reduce. This is an opportunity for Supervalu to keep its focus on increasing sales.

Supervalu was losing a bundle of cash in business operations due to its complex business model. Supervalu can post positive earnings after the elimination of low-performing stores. In addition, the new company will also have lower levels of debt and interest payments. At the end of Q3, Supervalu paid a massive interest expense of $422 million. After the payment of $422 million as an operating expense, the company posted losses.

At the end of Q3, Supervalu had $6.4 billion as long-term debt. After the sale agreement, Supervalu's debt level will be reduced to $3.2 billion. Now the debt levels look more sustainable. Supervalu also started negotiations for a $900 million asset-based revolving credit facility. However, I believe the new company has the potential to liquidate these liabilities. Supervalu can generate sufficient cash flow to fund these obligations. The company will also receive investments to improve its operations.

I believe the sale deal shows the productive in-depth strategic review process. Following the sale transaction, the company will have three sound, market-leading business units with far more efficient cash flows and far better EBITDA growth potential. I believe Supervalu's biggest dilemma was its massive debt and interest payments on those debt obligations. The sale arrangement will decrease the debt load by $3.2 billion. Therefore, financing costs will also be reduced.

Competition

Figures in Millions

Long-Term D/E

Net Income

Operating Margin %

Supervalu

Very High

-$479

-1.54

Kroger

1.8

$728

-0.5

Whole Food Market

0.001

$465

6.36

Safeway

2.3

$523

2.37

Source: Finviz.com.

Supervalu's main competitors are Kroger, Safeway, and Whole Foods Market (WFM). Supervalu needs to sell its products at lower prices to survive in the market. As the above table demonstrates, the grocery industry has a thin margin on sales. Supervalu needs to reduce operational costs to post positive results.

Summary

Six years after the Albertsons purchase, Supervalu is back to where it started. An operational recovery would be quite a challenge as the margins in the retail business keep diminishing. However, this time the company will focus on stable business segments. It will also have manageable debt with sufficient funds to meet obligations.

After the sale deed, the operational burden is likely to decrease, which can help the company increase revenue. Now, Supervalu should focus on maximizing efficiencies across the company. It should also work on right-sizing its operations. The recent sales deal can help the company to accomplish these goals. Therefore, I believe it is a win-win deal for struggling Supervalu.

Source: A Win-Win Deal For Struggling Supervalu