SuperValu: Down, But Not Out

| About: SUPERVALU Inc. (SVU)
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Although Supervalu Inc. (NYSE:SVU) barely missed its third quarter earnings expectations, its stock was taken behind the woodshed and almost beaten beyond recognition (losing 17%), as analysts ganged up on the grocer by issuing a swarm of downgrades. There were actually four, including a one notch debt reduction by Fitch.

Was the selloff warranted or an overreaction? Well, when you factor in that full year guidance ($1.20 to $1.30) was maintained and its gross profit margin improved 20 basis points, you could make an argument for the bull side, just like Cantor Fitzgerald did. That analyst (the grocer’s biggest cheerleader with a $10 price target) claimed the selloff was indeed an overreaction and that SVU faces structural challenges rather than underlying deterioration.

Where are the shares going? I have no clue, but the charts show significant support at the $7 level. If that fails, the next support should be found at the stock's previous all time low of $6.26. Is it time to be greedy when others are fearful? It just might be, because how else are you supposed to buy on the cheap? The name of the game in the business is buying low and selling high-- and to do that, you must act like a contrarian, by buying companies that are unpopular and selling them when their cycle reverses. Easier said than done!

Cost savings: the company is sharpening its pencil and reducing costs. Its SG&A costs dropped from 19.9% to 19.3%, while its interest expense contracted from $124 million to $119 million. The company’s “8 plays to win strategy” is its central theme to invigorate itself. One of the plan’s key goals is to be more adaptable to the needs of each of its geographical locations. This is accomplished by allowing managers more flexibility in accommodating their customers’ needs in a hyper-local focus, while simultaneously reducing shrink and improving operations.

Cash flow generator: The supermarket operator produces an enormous amount of positive cash flow ($1.2 billion in fiscal 2011) that it uses judiciously. The bulk of the cash flow --($725 million) in 2012-- will be used to remodel 90 traditional supermarkets and open 60 new “Save-A-Lot” locations, while $525 million is slated for debt reduction and $74 million for cash dividends.

SVU’s distribution segment is a force to be reckoned with. It generated $2 billion in third quarter revenue and just picked up an additional 26 locations from New York based retailer Western Bee, while its Save-A -Lot banner saw its same store sales rise 4% in the latest quarter (SVU’s distribution arm supplies its licensee locations).

Bottom line: With a forward multiple of just 6, and a very juicy dividend yield of 4.8%, it is apparent why value investors are intrigued with owning this one, as evidenced by Fidelity Puritan Trust’s recent 13 million share purchase, and a glowing Forbes puff piece. But the bearish camp has some compelling arguments as well (heavy debt, same store sales deterioration and encroaching competition), so it could be easy to conclude that the jury is still out on this one.

At this juncture, I would not try and pick a bottom, but I'd be inclined to add to my position when the shares start showing better relative strength (a rise above $8) because it is certainly worth the added price to pay, when you are able to piggyback an upward trend.

Disclosure: I am long SVU.