I have always been a proponent of a long position in SuperValu (NYSE:SVU). The dividend was fat and its earnings multiple was ridiculously cheap. I also was impressed by the supermarket chain's vast real estate holdings and highly profitable distribution business. Now that the company has no dividend, along with no guidance, I really don't see the point of holding the shares. Buyout possibilities have been minimized due to the reality of its staggering high enterprise value at almost $7 billion. To add insult to injury, the addition of pension liabilities and union contract ramifications are not helpful to those optimists holding out for some sort of takeover redemption.
Management stated it must reduce prices to become more competitive (thanks Captain Obvious) and end its sales slump, but how do you do so without sacrificing margins? It becomes an even more daunting task when considering the increasingly higher penetration by new competitors such as dollar stores, Wal-Mart, Target (NYSE:TGT) and the Whole Foods of the world. I am not sure it can be accomplished, consequently SVU might soon not exist as we know it today. Besides, SVU's union contracts make its cost structure that much higher.
I'll concede that I have been burned before with grocery retailers. Case in Point: Great Atlantic and Pacific Tea Company. I thought I was safe owning its debt rather than the equity, but after that iconic supermarket chain filed chapter 11, my bonds ended up basically worthless. My final thought: since I have already lost so much of my SVU investment, I might as well let my remaining holdings ride in the event that a miracle happens. Anytime I begin relying on "hopes and dreams" it is a sign that I am at the end of my rope.
It is pretty obvious that SVU's one day 50% drop had a negative impact on most supermarket operators' shares. When things are finally sorted out, and Mr. Market finally settles down, the other stocks in the sector will quickly bounce back. In hindsight, this will prove to be just another buying opportunity. After all, SVU's potential demise would mean the elimination of many stores and a ultimately a bigger piece of pie for the remaining operators.
Four key competitors examined:
Whole Foods Market (NASDAQ:WFM): I'll have to admit, although I think their stock is way overvalued, management has done a superb job in operating the company, as evidenced by impressive same store sales growth coupled with increasing gross profit margins. In two weeks, the grocer is expected to grow its earnings 22% to 61 cents on sales of $2.73 billion when reporting its third quarter results. I expect the company will have no trouble achieving this, however, at a premium forward multiple of 38, management will be compelled to raise guidance to protect the share price from a sure deflation event.
Safeway (NYSE:SWY): The fact that SWY sank in sympathy with SVU's results could be understandable, but the degree to which the shares crumbled was way over the top, especially when considering SWY is no "apples to apples" comparison. SWY is now selling near a 15 year low and a forward multiple of a mere 8 times 2012 estimates of $1.99 earnings per share. Unlike SVU, Safeway's same store sales, although anemic, have not been dropping. The fact that it has increased its cash dividend five years consecutively and bought a boatload of shares back in the open market is testament of its allegiance to its shareholders' cash flow prowess. SVU, on the other hand, hasn't bought back a single share while enacting two dividend cuts (the first at 50%, the second at 100%).
Earnings announcement could bolster shares: SWY will be reporting its second quarter earnings on Thursday, July 19th. Analysts expect the company's earnings to increase 20% from 41 cents to 49 cents on a 1.6% increase in sales (from $10.2 billion to $10.36 billion) which should be attainable. The real question is, will they tamper with the second half of the year's guidance? If they don't, the shares could be subject to a 10-20% relief rally.
Supermarket analyst David Livingston is certainly not a fan of SWY (claiming it is too plain vanilla and high priced) but admits it is a much better run than SVU. He also points out that its Canadian division could be packaged together with the company's Texas and Illinois locations in an effort to sell those stores at a nice premium. The company also owns a Mexican division and a gift card Business (Blackhawk) that it could easily convert to cash.
In a way, strange as it may seem, SWY's price implosion could actually be construed as good news, because when you think about, its massive $1 billion stock buyback commitment will benefit. The lower the share price, the more shares the company can buy. It will effectively be getting "more bang for the buck".
Wal-Mart (NYSE:WMT): It sells more groceries than any company on the planet, with just over 50% of its total sales now derived from food sales. To say its shares have made up for lost time recently is a paramount understatement. Its recent quest to convert more of its operation towards grocery sales has apparently paid off immensely. In the past two months alone, its shares have gained nearly 25% compared to essentially no share appreciation in the prior 156 month period. Let me repeat: the shares have risen more in the last two months than the entire 13 year period preceding it. WOW.
Thankfully, I jumped on the WMT bandwagon two months ago when I detected that its shares were going higher as the overall market sunk. This high relative strength clued me in to the fact that scared money was certainly targeting "flight to quality" names, and WMT being on the top heap in this category, was attracting new buyers. There is no doubt I want to increase my ownership, but the shares are way too overbought to chase at these levels, and should pullback to the $68-$70 vicinity.
Kroger (NYSE:KR): This one keeps quietly plugging along with modest identical sales gains growth, and a steady increasing dividend, however a 21 price multiple is way too rich for my blood.