Supervalu: After The Save-A-Lot Spin-Off, This $4 Stock Could Be A Ripe Merger And Acquisition Target

| About: SUPERVALU Inc. (SVU)

Summary

Supervalu has recently announced a new CEO appointment that could pave the way for more deal-making.

This company is expected to spin off its Save-A-Lot division in the next few months.

After the Save-A-Lot spin-off, Supervalu itself might be ripe for a buyout from a private equity firm.

At just over $4 per share, this beaten-down stock is extremely undervalued and could be worth $10 or more, according to analysts and a sum-of-the-parts valuation.

Supervalu (NYSE:SVU) is a supermarket chain with about 3,400 stores and around 35,000 employees. This stock has been hammered in the recent market correction and also because of a small miss on revenues. The recent drop in this stock appears to be a huge overreaction for a number of reasons. One of which is the fact that a single quarter does not make a trend and it should not have such a massive impact to the market value of this company. In late December, this stock was trading in the high $6 level, but now it is well below $5 per share. Another reason why this decline seems overdone is because many other retailers have missed on earnings or revenues lately, and this shows that this is not a company specific issue for Supervalu, but rather a sign of a competitive business environment. After a 35% plunge in the stock price, you might think this company reported a loss for the quarter, but it posted a solid profit of 16 cents per share for Q3 and now it trades for just around 6 times earnings which is extremely cheap for a grocery stock. Supervalu appears so undervalued now based on this low PE ratio, but it also looks extremely undervalued based on a sum-of-the-parts value and that is why this whole company could be poised for deals that could create significant upside.

Supervalu has a history of deal-making; in 2013, it sold Albertson's, Jewel-Osco, Shaw's, and Star Market Stores to Cerberus Capital Management which is a private equity firm. It now looks like more deals are in the works. Supervalu just filed a form 10 with the SEC on January 7, stating that it plans to move forward with a spin-off of Save-A-Lot. This move should unlock significant upside because Save-A-Lot has major expansion potential. The Save-A-Lot division, which has over 1,000 stores, is a low-price chain that competes with dollar stores, like Dollar Tree (NASDAQ:DLTR). Dollar Tree trades for about 23 times earnings and that is why it makes sense for Save-A-Lot to either be sold to a private equity firm or be spun off as a separate publicly-traded company.

Dollar Tree has annual revenues of about $12.6 billion and a current market capitalization of nearly $19 billion. That means it trades for about 1.5 times sales. Save-A-Lot had sales of about $4.6 billion, while Supervalu had total sales of around $17.8 billion in the past year. If Save-A-Lot were valued at that level, it would be worth nearly $7 billion which is way more than the currently depressed market capitalization of Supervalu of just about $1.1 billion. I don't expect it to achieve the same valuation metrics as Dollar Tree, but it clearly seems that it is worth much more than the market is currently giving it credit for. This is yet another reason why the focus on the recent miss on revenues is excessive. The sum-of-the parts value is ultimately what could drive this stock much higher, because it looks like Save-A-Lot will be sold for far more than the market value of Supervalu. A Barron's article gives details on why a Save-A-Lot spin-off could be valued at about 10 times EBITDA, which would be around $2.2 billion.

Save-A-Lot recently named Eric Claus as CEO, which seems to be positioning that company for the future as a separate company that will expand rapidly. The big question is whether this company will be sold to a private equity firm or if it will be spun off to shareholders as the company is now considering. A Reuters article says a number of private equity firms are interested in buying Save-A-Lot and that Supervalu is going to consider offers. The article also notes that a spin-off of Save-A-Lot could allow it to take advantage of typically high public market valuations for discount stores. If Save-A-Lot is valued at about $2.2 billion and spun off, that would leave Supervalu with about $13.2 billion in annual revenues, which is very significant and not much less than annual revenues of about $15 billion at Whole Foods Market (NASDAQ:WFM), which has a market cap of about $9.5 billion. This indicates a price to sales ratio of about .7 which is below the price to sales ratio of 1.5 times for Dollar Tree. Even if Supervalu is valued at price to sales ratio of just .3, it would be worth about $4 billion and that could be too conservative for a company with over $13 billion in annual sales.

On February 3, 2016, Supervalu announced it appointed Mark Gross as CEO, to replace Sam Duncan who said late last year, that he planned to retire. The new CEO has extensive experience in mergers and acquisitions in the grocery industry and that could be a sign that Supervalu could also end up being sold after the Save-A-Lot spinoff. A recent Wall Street Journal article states:

"Mr. Gross said in the statement that Supervalu "continues to explore and prepare for a potential spin-off of Save-A-Lot."

The next question for Supervalu shareholders may be: Does Mr. Gross stop there?

With an industry as fragmented as grocery, some of Supervalu's asset could be pretty interesting for the right party. "

The current share price and market value for Supervalu is way too low based on these considerations and on a sum-of-the parts analysis. Supervalu has a 52-week high of about $12 per share, and it now trades for just over $4 per share. That is vastly undervalued for a company that is annually earning about 73 cents per share in profit. I can see why management is moving to split up and sell off assets because this stock is not being fairly valued by the markets today. Assuming a $2.2 billion valuation for Save-A-Lot, and about $4 billion for Supervalu after the Save-A-Lot spin-off, that gives a total value of roughly $6.2 billion. Even after you pay off Supervalu's $2.7 billion in debt, that leaves a net value of $3.5 billion. But let's be even more conservative and slash another $1 billion off that amount and that leaves about $2.5 billion in net value that could be distributed to shareholders. That is equivalent to about $10 per share which is in the ballpark of what many analyst price targets are for this stock.

Analysts have set price targets of up to $12 per share for Supervalu. Morgan Stanley (NYSE:MS) has set a price target range of $8 for the base case scenario, which still implies almost 100% upside. This Morgan Stanley analysis was updated after the recent earnings report and it is based on a sum-of-the-parts valuation of the company that reflects their "base case", but their bull case valuation is $11 per share. In January, TheStreet.com published an article that suggested Supervalu shares could have significant upside and set a 6 to 12 month price target of $12 per share.

Whether you look at the price to earnings multiple, industry valuations, sum-of-the-parts valuations, or analyst price targets, Supervalu shares are very undervalued now and offer significant upside potential. It is also worth noting that in this time of economic uncertainty, investing in recession-resistant businesses like food and groceries could be seen as a defensive move.

Data is sourced from Yahoo Finance. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.

Disclosure: I am/we are long SVU.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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