SUPERVALU's (NYSE:SVU) restructuring efforts are going on as the company has expanded its wholesale segment with the acquisition of Unified Grocers. The acquisition is complementary and will increase the scale of the wholesale operations of the company. SUPERVALU is becoming interesting due to the focus on margin enhancement from its core operations. However, it is still a long way from it where it needs to be in order to be competitive and grow its margins.
This acquisition will take SUPERVALU's wholesale business segment to around 70% of its total operations and increase the scale considerably. The combined company will have total sales of around $16 billion. Wholesale operations are generally low-margin and revenue growth is essential for margin enhancement. In this regard, the company has taken a positive step as this acquisition will increase its sales considerably. Total value of the deal is $375 million. The cash outlay will be $114 million while the remaining will be in the form of Unified Grocer's net debt ($261 million). The assumption of debt will weaken the debt profile of the company to some extent. However, the positives coming from this deal should outweigh the possible negatives to the credit metrics.
The company is expecting around $60 million in run rate cost synergies by the end of the third year. These synergies are one of the key reason deals like this make sense for SUPERVALU. Keep in mind that wholesale business operations are extremely competitive and pricing pressure usually results in lower margins. There are a number of competitors fighting for the same customers. There is little differentiation when it comes to products. As a result, cost savings become a key part of margin enhancement strategy. For this reason, we should be paying attention to the expected synergies from the deal and how successful SUPERVALU is in achieving these cost savings in the next three years.
The acquisition is accretive to the earnings as it increases revenue and will certainly add to earnings. First year will show some acquisition and integration costs, which might bring the final EPS down a little. However, in the following years, this acquisition should augment SUPERVALU's earnings generation.
The addition of Unified Grocers' debt will take SUPERVALU's long-term debt to over $2.45 billion. Based on last year's EBITDA, the leverage ratio (Debt/EBITDA) will be over 3.4x. However, last year's EBITDA also includes EBITDA from Save-A-Lot. This segment was one of the key contributors towards SUPERVALU's operating income and EBITDA. The sale of Save-A-Lot is likely to reduce full year EBITDA going forward (I explained this sale in this article). As a result, the leverage ratio will rise. I am expecting it to be around 5x as the acquisition is completed. SUPERVALU's EBITDA, post Save-A-Lot sale, will be around $533 million. If we add Unified Grocers' EBITDA (around $40 million) and adjust for additional borrowing in order to complete the deal, we are getting a leverage ratio of close to 5x.
The company is sacrificing credit profile to some extent in order to have a larger scale of operations. It is the right move as this acquisition will have a long-lasting effect on margins and operating income. The complementary nature of the businesses will allow SUPERVALU to realize synergies from core operations and grow core operating income. As the core earnings and cash flows grow, the credit profile will improve.
The stock price has been sluggish in the last few months. It is understandable as the company is going through a lot of structural changes. The market is yet to determine the true direction of the business. However, this acquisition should clarify a lot of things for the market. It shows that the management wants to grow the business mainly through its wholesale operations, and it also hints that they are not afraid of making deals in order to increase the scale of operations. In fact, this might be the preferred course of action as organic growth is quite challenging in this segment. In my opinion, SUPERVALU is becoming a more focused and better business with this acquisition.
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