SuperValu 2022 Bonds Offer 7.6% Yield To Maturity

Summary

• SuperValu just completed a transitory year moving away from retail towards wholesale.
• SuperValu does not have significant debt maturities until 2022.
• Company guidance combined with future earnings outlook can help bond investors determine the company's ability to service its debt.

SuperValu (NYSE:SVU) complete a transitory fiscal 2018 with its fourth quarter earnings report last week. The company missed earnings expectations and came in with lighter than expected revenue. Despite these signs of weakness, SuperValu’s 2022 maturing bonds are priced near par and offer a 7.6% yield to maturity thanks to the 7.7% coupon rate.

Source: FINRA

SuperValu saw a notable increase in revenue during fiscal year 2018. This was due to the company’s acquisition of Unified Grocers. The telling statistics in SuperValu’s earnings performance are its gross profit and operating profit. Gross profits were slightly higher, however, due to the higher revenue, the company’s gross profit barely made 10%. After SG&A expenses, operating profit was nearly identical to 2017. This meant that with the higher revenues came even greater cost pressures that hurt profits.

Source: 10-K

With the acquisition of Unified Grocers in June and Associated Grocers of Florida in December, SuperValu saw an increase in assets during 2018, despite a large drop in cash. The company also increased its long-term debt by nearly $450 million during the year. Despite margin pressure and higher debt, the company managed to grow book value during the year.

Source: 10-K

SuperValu’s cash flow statement likely shows the greatest degree of weakness compared to the other two balance sheets. On the year, SuperValu generated only $135 million in operating cash flow compared to $364 and $426 million in the prior two years, respectively. Combined with the $276 million in capital expenditures, SuperValu had negative free cash flow in 2018. To cover its free cash flow deficit and $240 million in acquisitions, the company had to borrow nearly $100 million and burn through over $280 million in cash on hand.

Source: 10-K

SuperValu is fortunate to have a low debt maturity balance over the next three years. This is critical to helping the company transition its business away from retail and towards mostly wholesale. The company is guiding a return to positive free cash flow in 2019 with earnings growth and the sale or leaseback of eight distribution centers.

Source: 10-K

Source: Company Earnings Slideshow

Source: Company Earnings Slideshow

The company stated in its fourth quarter earnings presentation that it was dedicated towards utilizing free cash flow towards debt reduction. While the company hinted in the slide that further debt reduction is absent M&A, SuperValu’s low cash position and high leverage make it unlikely that it will engage in further M&A in 2019. Analysts are optimistic that SuperValu will grow earnings beyond 2019, which should be advantageous towards further debt reduction.

Source: Company Earnings Slideshow

Source: NASDAQ

Based on the combination of 2019 guidance and earnings estimates for 2020 and 2021, I believe that SuperValu will grow its cash balance to $763 million by the end of 2021, more than half of which is related to the sales and leaseback transaction. Ultimately, if the company’s earnings growth were flat in 2022 and 2023, it should be able to pay off its larger debt maturities with cash and have just under $300 million left over.

Source: 2019 Guidance combined with Earnings Estimates in internal spreadsheet

Bond investors should carefully monitor SuperValu’s free cash flow in 2019 to ensure that it returns to positive, even without the sales transactions. The company’s margins should also be monitored as shrinking gross margins will impact operating cash flows. Despite the margin headwinds, SuperValu’s wholesale transition should provide the cash necessary to fund the 2022 bonds to maturity.

CUSIP: 868536AW3

Price: $100.24

Coupon: 7.700%

Yield to Maturity: 7.642%

Date of Maturity: 4/27/2022

Credit Rating (Moody’s/S&P): B3/B-

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

I am long SVU 2022 maturing bonds.