Supervalu's Double Positive

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 |  About: SUPERVALU Inc. (SVU)
by: Jeffrey Moore

As of late, I have been increasing my stake in SuperValu (NYSE:SVU). I have not added any in regard to my option position (which I went into knowing that it may turn out wildly unprofitable), but have gone long a decent bit of the equity. It isn't that I really have anything to add to the discussion that many others have already covered, but, there does seem to be a ton of pessimism in regard to the company - which is something that I generally try to flock to.

To give some history, one of the first value guys to talk about the company was Saj Karsan, who really liked the company and even compared investing in it to partaking in an LBO. There was also Frank Voisin who liked the stock. In another corner, you have John Hempton, who doesn't really like the company, but isn't down for shorting it either. I personally take a hybrid of these views. It's not because I am so sure that things will turn out well for the company, but, mainly because I have a small bit of faith in the management team and think that relative to the risk that I am taking on by being long the equity, I stand a pretty good chance to have a multi-bagger in my portfolio.

Honestly, a lot of my thesis in regard to this stock is overly simplistic and unresearched. As was pointed out here, we have a situation where the bonds of the company trade for more than par; a rarity for companies that are saddled with so much debt. So, the bond market seems to be agreeing with what I already thought, based on their cash flow: there is little chance of the company defaulting on their debt (this is especially true when looking at the convenants of their debt, relative to the healthy ratios that they sport).

Given the management team that has been hired, I am suprised that people are freaking out over margin and revenue shrinkage. The CEO came to the company from Wal-Mart (NYSE:WMT). Given that company's culture, who in their right mind would expect for him to do anything but cut prices to try to gain market share? Furthermore, who would expect for the customers to immediately say "Wow! Prices at Sav-a-lot are better than ever! I am going to shop there now!" These things take time to filter through, especially when you consider that the company is closing under-preforming stores at a rate that outpaces the openings of their Sav-a-lot locations (which in my part of the country are opening like crazy). Long time readers of this blog will attest to the fact that even Steak 'n Shake took time for the customers to get what the company was doing. And that was probably one of the best turnarounds in history. Add to this that the company has shrunk SG&A by more than a billion dollars in last few years and I get optimistic.

Moving along, we see that over 1/3, that's right, over 33%, of the company's shares are sold short. Again, I have trouble thinking of many companies where this occurs for such a long period of time. With a short ratio (meaning, the number of days that it would take for short sellers to cover their position based on historical volume) north of 13, I start to froth at the mouth. While the float isn't crazily low as was the case with, say, Farmer Brothers (NASDAQ:FARM) (which came back both operationally and in price more quickly than I ever would have thought), it seems that if SVU posts any news other than "Hey guys! Sorry that we screwed up... we are closing 1/2 of our stores, our distribution/logistics service lost almost all of its customers, and by the way, we are cutting the dividend," it could mean great things for the stock (knock on wood).

Additionally, with so many shares short, it seems to me that the shorts had better be right about the goings on at the company. Otherwise, a declining price could actually be of benefit to long term holders of the equity due to how the company carries its intangibles. They write down goodwill as their share price falls. When a ton of short sellers come in to play, that effectively reduces the earnings of the company in a negative feedback cycle, as the goodwill goes against the company's income. This leads to lower earnings, which in turn, will potentially lead to more people shorting the stock. I view this as a double positive due to the depression of earnings that makes the share price goes down, which, essentially gives the company a tax benefit, allowing them to pay down debt that much quicker, as well as open up more high margin Sav-a-lot stores. If earnings and share price ever start to rebound, look out above.

All this said, I wouldn't want to make this a super huge position, say, 1/2 or even 1/4 of my portfolio, but for me, there is a place for it. I don't really see a situation playing out in the coming years where the company doesn't trade for multiples of what it is at. Time will tell. I do know that I will be shocked if the stock prices (coupled with the operations of the company) stay roughly where they are today.

Is the company in a brutal industry? Yes. Are they the best of breed? Hell no. Am I catching a falling knife? It is a strong possibility. Is the market discounting every marginally good thing and expecting every bad thing that could happen to the operations of the company? I lean towards a yes.

Disclosure: I am long SVU equity and options and Farmer Brother's equity.