How to Play Supervalu: Buy Its Bonds

Includes: COST, KR, SVU, SWY, WMT
by: Jake Berzon

I first wrote about SuperValue (NYSE:SVU) at the end of 2008, here, after picking up some shares at $12.46. Fifteen days later I sold those shares at a profit of 43.5%. By the end of the day this Thursday, SVU shares were once again trading within pennies of the price I paid for them in December. Attractive? Perhaps. Certainly cheap. Much less expensive (valuation wise) than any of the competitors - Kroger (NYSE:KR), Safeway (NYSE:SWY), Costco (NASDAQ:COST) and Walmart (NYSE:WMT).

But, and this is a big but, SVU's management team just hasn't been able to get it right. They screwed up on their acquisition of Albertson's and they have had trouble positioning themselves to compete effectively in today's troubled economic environment. Yes, they can cut costs, lower margins and feature generics, but keeping loyal and satisfied customers coming back week after week takes much more than that. For that you need to create an attractive, lasting and consistent presence and I am not so sure that SVU, as a corporation, can do that any time soon. Without such a corporate-wide sustainable competitive advantage, Supervalu may simply be forced to compete with Walmart on price and location.

Does that mean that SVU stock is no longer a bargain in the mid $12 range? It is still temptingly cheap at these levels and it may still be a bargain. But there is a significant risk that Supervalu will go the way of A&P in the 70s (from preeminence to irrelevance) in a matter of a decade. Should that happen, Supervalu's value will catch up on the way down with its stagnating stock price. Even if that happens, however, it is extremely unlikely that this company will declare bankruptcy or go out of business.

How about corporate bonds?

This suggests a different and safer way to invest in Supervalu - buy their bonds. New 8% coupon bonds maturing on 05/01/2016 (CUSIP: 868536AT0) were just issued a couple of months ago. They are rated BA3 by Moody's and B+ by S&P. I believe that the low ratings on these bonds, while justified from the point of view of debt ratios, are nevertheless overly pessimistic, considering the company's ability to operate profitably while supporting the large debt load.

Supervalu bonds' maturity date is a bit further than I would like to keep these days just for "fear" of future inflation. But then again, I see some folks advocating paying off mortgages as a form of investment. For many of us this would be the equivalent of locking the money up for under 6% for up to 30 years, which I find to be much less palatable. Given the slightly higher risk bond alternative, I chose it, picking them up just below par value at 98. As this is my first venture into individual corporate bonds, I started with a small stake.

P.S. I would like to thank Vitaliy Katsenelson for pointing out a decent yield and good availability of these.