Is Supervalu (SVU) walking the path of Kroger (KR)? Supervalu is now in survival mode and its next step seems to be cutting costs to protect margins. We can't ignore that end of the day its all about the top line improvement. To make situations worse, the weak economy coupled with weak consumer spending and aggressive competition in the grocery business might add obstacles to the company's strategic plans for any short term financial fix.
It took Kroger close to 5 years to turnaround its business and that too in a stronger economy and a less crowded competitive environment. We don't think the current valuations of the company should be a cause of excitement within the investment community. If anything, it should create more cautiousness.
Managements new and improved strategic plan for survival:
- Cutting costs in the form of store closures, laying off employees, and cutting capital expenditures
- De-levering - Increased debt reduction of $450-500mm versus the previously announced $400-450mm, suspending the dividend, lowering capex by $200mm and replacing its revolver with a restrictive term loan securitized by real-estate. The company replaced its senior credit facility with an asset-based lending facility and term loan secured by a portion of the Company's real estate, which will remove restrictive covenant concerns and increase financial flexibility. The financing is expected to close in August, 2012
- Re-adjusting their pricing structure, a goal to be achieved by 2014 - Given the competitive environment, this might be a challenge. Most recently, Wal-Mart (WMT) decided to invest $2b in price reductions. This should be followed by others in their peer group
- Other alternatives being analyzed by the Board and the newly hired Financial Advisors - We understand these alternatives to possibly be selling assets or selling the company as whole. Supervalu has hired Goldman Sachs and Greenhill & Co. to weigh alternative options for the survival of the company
Yesterday, Supervalu pre-announced Q1 EPS of $0.19 well below consensus of $0.38 driven by weaker same store sales growth reported as down 3.7%. To add pain to injury, management suspended the dividend, withdrew earnings guidance and made several strategic announcements details of which are mentioned above. The biggest damage to the stock which declined 44% percent with a trade range of 2.7600 - 3.3900 was the suspension of the dividend. The 52-week range has been 2.7600 - 9.4400 with an annual return of - 65%. The Eden Prairie, Minnesota-based company's shares has fallen 35 percent this year through yesterday, putting it on course for a fifth straight annual drop. Additionally, Supervalu announced a new ABL facility and a real estate backed term loan.
Supervalu is now no longer restricted by the debt covenants. The only downside is that the interest expense related to the $850mm real estate backed loan will be a negative to earnings going forward. The company provided more visibility on Save-A-Lot, the crown jewel of Supervalu which contributes 30% to operating profit and 15-20% to EBITDA. Supervalu's decision to break up the profitability of the division is important but still a challenging business since the deterioration of its sales which reported a decline in IDs of 3.4% in Q1-2013 versus a 3.2% increase at the end of FY2012.
On the company's balance sheet - Supervalu has cash & cash equivalents of $151 million with total long-term debt of approximately $6 billion with approximately 3.2 billion due 2014-2015 and the remaining in 2016-2017. Close to $5b in debt which is in the form of senior unsecured notes hold covenants with cross-default covenants. Although the company was in compliance with all such covenants and provisions, replacing the term loan with a ABL facility has provided the company with more flexibility.
Valuation and a potential takeover target: The stock opened today at $3.38 and an Enterprise Value of $6.7 billion. Short interest in the stock is approximately 49% some of which is due to pairs trading with Safeway and Kroger. SVU trades with a EBITDA multiple of 3.9x versus Kroger's 6.7x and Safeway's 4.7x making it the most attractive of its peer group for a possible takeover. We rather look at EBITDA versus Earnings growth considering earnings are negative and fundamentals are the weakest with no short term catalyst to trigger an improvement. We still don't believe that it would be easy to line up bidders for the company as a whole. Given its high leverage, tremendous need for restructuring and a weak operating environment, we still think that selling Save-A-Lot might be the best option for the company. Historically, Save-A-Lot has been a saving grace for the company.
This might be the environment to acquire cheap assets but keep in mind that investors have lost patience with losing businesses. Given the economic reports on consumer spending and the overall mystery in the global economy, investors will not be jumping to grow another grocery business when consumer spending is geared towards discount retailers such as Wal-Mart
Conclusion: We think company management has to build credibility and show us the light at the end of the tunnel before we get excited about shopping Supervalu . The fundamentals supersede the technicals in the case of Supervalu, which we believe is a long term goal in this weak economic environment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.