First, I must say that overwhelmingly, turnarounds don't work. Warren Buffett is peremptory in saying that he doesn't try to invest in turnarounds:
"Turnarounds" seldom turn. Be in a good business purchased at a fair price [rather] than in a poor business purchased at a bargain price.
So one could say that Supervalu (SVU) being a turnaround story as well as a poor business trading at a bargain price isn't the best of situations. And the market would certainly agree with that, given the punishment it has been dishing out to Supervalu ever since 2008, with the stock down from near $50 to $4.35 today.
But is Supervalu really such a lousy business?
Supervalue operates wholesale and retail food stores. These stores serve rather stable local markets, for a rather stable need. Yes, Supervalu blundered back in 2006 by buying Albertsons, in a deal where it assumed $6.1 billion in debt as well as paying $6.3 billion in cash and stock. This meant SVU went from having just little more than $0.2 billion in net debt at 2005 year end, to having around $7.8 billion at 2006 year end.
Not long afterwards, the 2007-2009 great recession hit complicating matters even further.
Still, during 2009 Supervalu brought in Craig Herkert from Wal-Mart (WMT), and he's been working on paring down its debt ever since. As of February 25, 2012, net debt stood at $6.1 billion.
Although the 2011 and 2010 earnings were seemingly horrid, with -$7.13 and -$4.91 EPS, those came about essentially due to goodwill impairments. So the underlying picture is not as awful as it seems, with earnings estimates for 2012 standing at $1.29 per share and not dropping off a cliff. If such estimates are attained, this would mean SVU is presently trading at just 3.4 times forward 2012 earnings.
Free cash flow
Even more tellingly, SVU is still generating significant amounts of free cash flow. During 2011 this came to around $400 million ($1,056 million in operating cash flow minus $661 million in capex). Out of the $400 million in free cash flow, only $74 million went to pay the "incredibly high" dividend. This broadly means that the dividend has a good chance of surviving, even while standing at a very juicy 8% right now. Although the company could cut the dividend, the savings would be so minor that it wouldn't make much sense for all the grief it would generate.
The main problem
Financially, Supervalu seems safe enough. So the market is basically seeing a competitive nightmare having a negative effect on the very short term. Sure, Supervalu has some trouble competing with Wal-Mart as well as Kroger (KR) and others, and it shows in Supervalu's declining revenues, but the near term impact of such competition and Supervalu's financials does not seem to warrant the incredibly aggressive shorting it's being subject to, with 48.9% of the float shorted already.
Conclusion
Given Supervalu's financials, the slow-moving nature of the market it acts in, the actions being taken to pay down its debt, the sustainability of its dividend in the medium term and the wildly large short interest, it would seem that Supervalu is a compelling turnaround story that will produce a huge short squeeze at the minimum hint of good news.
As such, it seems a good enough speculative bet on the long side, though with "long shot" odds due to the difficulty of turning around operations faced by any company.
Disclosure: I am long SVU.
