Despite the news that Goldman Sachs (GS) has upgraded Supervalu (SVU) from sell to neutral due to large selling in the stock (the market has discounted all the negatives), with a price target of $3, we still firmly stick to our earlier view that investors should stay away from Supervalu. The stock is trading at 52 week lows and has a high short ratio of 16 days. However, there are no significant positive future prospects that could drive the price up, or deliver profitability.
Supervalu is a wholesaler and retailer chain of grocery. It sells food, pharmacy and personal care products. Amongst other brands, the company has a discount chain under the name of Save-a-Lot.
Following are the points that support our view:
The company has consistently shown a decline in same store sales for the past three years; from -1.2% for 2009 to -6% for the year ending February 2011, and a further -2.8% for the last year ending February 2012. A comparison with competitors (Wal-Mart (WMT), Kroger (KR) Safeway (SWY)) is given below:
SVU's customer base is being eroded by big players like Wal-Mart (WMT), which are able to offer much lower prices in the present uncertain economic conditions. WMT's market share amongst grocery stores has increased from 13% in 2002 to 33% in 2011.
The company had to suspend dividends to introduce further price cuts in order to entice customers to shop at SVU.
Its Save-a-Lot chain of 1,280 discount stores is also not doing well, with comparable store sales dropping 3.4% last quarter. This chain had been the primary support for SVU's cash flows.
Last quarter's profits came out to be $0.19/share, 50% less than analyst estimates of $0.38/share.
The long-term earning growth rate is -5%. The estimated EPS are expected to be $0.77/share for the fiscal year 2013, and $0.74/share for the fiscal year ending 2014.
There are speculations in the market regarding SVU as a possible buyout candidate. We are of the opinion that the $6 billion in debt is a deterrent for prospective buyers. Of that $6 billion, $1 billion is due in the next two years. The interest coverage ratio is an unfavorable -1.9 for the company. SVU had an unfunded pension liability of about $1.7 billion on a pre-tax basis at the end of its last fiscal year. Moreover, the company does not even have an exceptionally good cash position to be attractive for buyers. The cash flow from operations (CFO) has been declining over the years. It was $1.5 billion in the annual results for the year ending 2010 and was $1 billion for year ending February 2012. Looking at the current scenario, this YoY decline can be expected to continue even though last quarter's CFO was positive ($538 million), which is good news for the immediate debt payments that are due.
A turnaround strategy includes suspending CAPEX, paying $450-$500 million of debt this year, and layoffs and cost-cutting to save $250 million over the coming two years. The company also wants to expand product lines that have higher margins. It is still doubtful whether this strategy would be enough to take SVU out of its troubles.
To reiterate, we recommend staying away from SVU. It does not have the fundamental results to support a turnaround success at the moment. However, the incredibly high short ratio means that it is unwise to be short SVU and investors should wait for a spike in share price to initiate any short positions.