When evaluating dividend-paying stocks for addition to the portfolio of our Dividend Growth Newsletter, we like to assess the long-term safety of a company's dividend via our Valuentum Dividend Cushion™. SuperValu (SVU) registers a -12.5 score on our Dividend Cushion measure, which suggests to us the company will have some trouble covering its dividend payments going forward (on the basis of both its future cash flow stream and capital structure).
Such a poor score (among the worst in our coverage universe) also suggests that the company could eventually cut the dividend meaningfully, as the firm has done in the past two years. We don't think the dividend is sustainable at the current payout rate, and we think these levels ($0.35 per share on an annual basis) will be the high-water-mark for the company's dividend for some time.
Food distribution going strong…
Although we don't predict a rosy future for SuperValu, there's no doubt that they have some valuable pieces. The distribution to independent stores has actually remained profitable in spite of challenging economic conditions and rising food prices. In fact, it was the only segment profitable in fiscal year 2011. Further, the Save-A-Lot franchise, which is consolidated under this segment, fits the needs of lower-end consumers. Save-A-Lot can actually compete with the Aldi's and Wal-Mart's (WMT) of the world, unlike its traditional grocery store brethren. Though this segment seems to be performing well, we're afraid that isn't the case for the rest of the business.
Grocery stores face a challenging road
We're generally not huge fans of grocers, and SuperValu is probably not the best-run firm among peers either. When we profiled the regional grocery store player, Roundy's (RNDY), in the article here, we mentioned that the grocery store business is facing a lot of competition from 1) younger, hungry companies and 2) Target (TGT) and Wal-Mart , which are expanding grocery-store operations rapidly. Both firms often beat traditional grocers on price, while offering a one-stop-shop convenience for a plethora of items that seems to resonate well with customers that face higher energy prices.
This leaves the traditional grocers in a precarious position. While they have trouble competing on price, they also can't fill the void of the high-end grocers like Whole Foods (WFM). Since SuperValu's balance sheet has a net debt position of nearly $6 billion, or about 4.5x its market cap, the company has been weighed down by outsize interest payments that have restrained its ability to reinvest in stores. In our view, several of their stores look "tired" and worn down.
Relative to its peers, SuperValu spends significantly less on capital expenditures. While the numbers for 2011 aren't available yet, SuperValu spent $8 per square foot versus over $15 just two years ago. Since the grocer doesn't offer the low prices of Wal-Mart or the wholesale bargains of Costco (COST) or Sam's Club, we think SuperValu stores needs to lower prices (and take a hit on the gross-margin level) or embark on an expensive refresh of the stores. We don't think the latter is likely to happen given the health of its balance sheet.
Ultimately, the dividend is too risky.
With the mediocre, margin-light traditional grocery model not working, we don't think SuperValu is a very good dividend story. While its yield looks tempting at roughly 5.7%, we're not confident in the firm's payout ratio and would not be surprised to see it cut in the coming years on the basis of our Valuentum Dividend Cushion analysis.
Unless there's an unexpected turnaround at the company, there's not much that excites us about the company at this point. We view the shares as fairly valued and particularly dislike its substantial financial leverage. We remain on the sidelines.