Mark Krieger's  Instablog

The way Wall Street has turned on SVU, you’d think the company had one foot on a banana peel  and  the other  on a “slip and slide”. The Street has literally wrote it  off as damaged goods because of its heavy debt load, as it is evident that most don’t want to touch it with a ten foot pole. The good news is this kind of disdain usually presents opportunity for those investors with a “glass half full” mentality. The  overall aversion to this equity makes it an attractive play to value seekers searching for a compelling contrarian position to open.

 What is Wall Street afraid of? It’s all about the debt, and at $8.1 billion (including lease obligations) it is gargantuan. It’s debt to equity ratio at 2.83 is twice that of KR’s ratio of 1.38 and 3.5 times SWY’s ratio of .79.  The Street is also continually worried about the competition- not only the other Grocers, but also the likes of behemoths WMT and COST. Add in the anxiety brought on by Union contract negotiations, and you have the perfect recipe for  Wall Street loathe of this sector. It has reached such lunacy proportions, I wouldn’t be surprised if they are concerned about the development of a pill that replaces the need for food. It just makes no sense these guys can love stocks with multiples of 30-40, yet are scared to death of companies with a PE in the single digits.

 Sales slump : there is no doubt SVU’s top line has been  disintegrating. The company guided   its Identical Store Sales will fall 3% in 2010, but at least it has some diversification-its supply chain service segment provides wholesale distribution to other retailers and represents about 25% of its total sales. Although sales dropped about 5% from $13.3 billion to $12.7 billion in its most recent quarter, the company’s all important gross profit margin ticked down a meager 60 basis points to 22.4%, while its SG&A costs eased  5%, to $2.49 billion or 19.6% of sales, as its efforts to control costs seem to be producing tangible results.SVU was also able to pare its interest expense by almost 7% from  $190 million to $177 million.

 

Things are not that bad: there are plenty of positives to  offset the wall of worry on this one. The debt is coming down: management expects to pare debt by $700 million in 2010 with cash flow from operations as well as the proceeds from the sale of its Salt Lake City operations.

The dividend seems secure, it’s current yield of 4.8% is no doubt rich, but with a payout of  69 cents per share, and 2010 earnings guidance of $1.95 to $2.15, this amounts to only 35% of earnings being paid out and adds up to more than adequate coverage for the dividend. The best news of all is that this stock is it is selling at unheard of, seven times 2010 earnings estimates (both SWY and KR have a forward PE of 10). No other supermarket chain has a valuation this low, and a dividend yield this high-Too good to be true? Maybe so, but warrants the risk. New leadership has evolved. Craig Herkert, formerly a Wal-Mart executive recently took the CEO reigns and will focus on cleaning house and incorporating many of WMT’s   winning ways into SVU’s culture.

 

Owns locations rather than rents: SVU owns the real estate on 1559 of its 2421 locations. That translates into lower costs as the company is not subject to lease increases on those locations. Secondly, many of these properties have been paid off since they were acquired many years ago and occupancy costs at those early locations should be relatively cheap. There is also plenty of hidden value within its real estate holdings as many of the properties have appreciated substantially  since they were acquired and this fact is not brought out in the financial statements. SVU is selling near book value and has an outrageously low price to sales ratio of only .07.

 

Bottom line: The market is   pricing these shares almost as if the company is destined for failure, but overreaction is commonplace on Wall Street- SVU’s bad news has  probably been factored in and then some.  Obviously the company needs fixing, but that is a good thing because it presents the investor with the potential for the biggest reward, once the repairs start to take hold. The shares are trading at the same valuation they were 15 years ago. The stock has more upside potential than downside risk, and even if the turnaround process takes longer than expected, at least you will be paid a nice dividend for your patience. Who knows? This one could even become an eventual  acquisition target!