Hidden Value In SuperValu
Summary
- SuperValu’s current market capitalization reflects only a fraction of its sum-of-the-parts value, indicating a strong asymmetric risk/reward opportunity.
- Catalysts include further real estate monetization, upcoming debt reductions, an activist campaign, and a review of strategic alternatives that may lead to an outright sale of the Company.
- Expect 1-2 years on the high end for realization of these catalysts, with a potential return of 21-36 percent based on the last closing price.
Executive Summary
The name “SuperValu Inc.” (NYSE:SVU) is an apt one to describe this opportunity from a value investing perspective. A sum-of-the-parts valuation indicates a tremendous amount of hidden value in the Company’s owned real estate portfolio and retail segment. The Company is undertaking a monetization strategy of its owned real estate through a series of sales and sale-leaseback transactions, with the proceeds earmarked to pay down debt. Identifiable catalysts on the horizon include an upcoming reorganization of the Company into a holding company, further monetization of owned real estate, and the completion of an ongoing review of strategic alternatives. It’s also important to note that shareholder interests are being protected by an activist investor by the name of Blackwells Capital, whose critical yet constructive communications with management and shareholders have arguably spurred insiders to take urgent steps towards highlighting shareholder value. Our analysis below puts a conservative estimate of price appreciation for SVU stock between 21 and 36 percent over the next 12-24 months.
Background/Business Overview
Headquartered in Eden Prairie, Minnesota, SuperValu Inc. (“SuperValu”) is a U.S. grocer with two primary business segments:
- Wholesale (~78 percent of FY2018 net sales): With 28 distribution centers (DCs), the wholesale business serves as primary grocery supplier to ~3,323 stores, with customers including independent retailers, regional and national chains, military commissaries, as well as SuperValu’s own corporate-owned retail stores. EBITDA has continued to show positive growth over the years.
- Retail (~21 percent of FY2018 net sales): The retail segment is comprised of 114 stores primarily under the grocery banners of Cub Foods, Shoppers Food & Pharmacy, and Hornbacher’s. The retail segment has struggled with declining performance in sales and EBITDA, and has been a source of negative operating income over the last two fiscal years.
Note that about 1 percent of net sales is derived from the “corporate” segment, which consists of revenue from transition services agreements (“TSAs”) for providing back office support functions for Albertsons and Save-a-Lot. These TSAs are set to expire within the next year.
Since January 2006, SuperValu common stock has underperformed not just its peers but also in relation to over ~95 percent of the stocks on the S&P 500. The large decline in public stock market value has created an attractive opportunity in SVU, and has attracted the interest of activist investor Blackwells Capital (“Blackwells”), which is now pushing for the realization of shareholder value through strategic alternatives. With an ~8% stake in SuperValu, Blackwells Capital has issued several letters and a presentation since October 2017 criticizing the Board and management for their lack of progress and urgency in turning around the business.
Blackwells has released a detailed plan to maximize shareholder value, which includes monetizing its entire owned real estate portfolio, separating the business into its wholesale and retail divisions, and seeking a strategic sale of each division. It believes that by implementing its plan, SVU shares can appreciate to a share price between $42 and $45 per share, for an approximate 2.0x return over the stock’s last closing price. In addition, Blackwells has nominated six candidates for election (out of nine total) to SVU’s Board at the next shareholder meeting in August 2018.
Management has responded to pressure from shareholders and Blackwells by crafting a four-point plan titled the “Strategic Transformation”. The four primary strategic initiatives under this plan include:
- Shifting SuperValu’s business focus towards the wholesale division;
- Opportunistically monetizing non-core real estate;
- Using real estate proceeds towards debt reduction; and
- Opportunistic M&A.
The Strategic Transformation has a clear overlap with many of Blackwells’ objectives, and if the Company is able to execute on any one of these initiatives, it will be to the benefit of all shareholders.
During FY 2018, the Company began implementing its strategic initiatives in concrete ways:
- With the acquisitions of Unified Grocers, Inc. (“Unified”) in June 2017 and Associated Grocers of Florida (“AG Florida”) in December 2017, SuperValu has added ~$5 billion in annual net sales to its wholesale business. Both acquisitions are expected to produce run rate cost synergies of at least ~$95 million by the end of third year following the respective closings; SuperValu has already realized ~$23 million of these synergies during FY 2018.
- In March 2018, SuperValu disclosed the sale of 21 out of 38 “Farm Fresh” retail stores for gross proceeds of $53 million, with further plans to sell the remaining Farm Fresh stores, 38 “Shop ‘n Save” stores, and 22 “Shop ‘n Save East” stores (“Discontinued Retail Stores”).
- In April 2018, SuperValu announced it had entered into a sale-leaseback deal for eight DCs, for net proceeds of $445 million.
Proceeds from the Discontinued Retail Stores and the DC transactions above have been earmarked to pay down debt, which would lower outstanding debt to ~$1,247 million.
The Value of Retail Segment and Owned Real Estate is Missing From Market Value
Between fiscal years 2016 and 2018, the wholesale division has grown EBITDA from $267 million to $310 million. A normalized annual EBITDA for the wholesale segment can be very conservatively estimated to be ~$270 million. Layering in annualized EBITDA contributions from the acquisitions of Unified and AG Florida of ~$55 million in total, plus low-end synergies of ~$50 million, less the increased rent expense from the sale-leaseback transactions of $37 million, indicates a normalized annual EBITDA of $338 million for the entire wholesale division.
Applying a 6.0x EV/EBITDA multiple (the lower range of wholesale peers SpartanNash (SPTN), Sysco Corporation (SYY), and United Natural Foods Inc. (UNFI)) produces an enterprise value of ~$2,028 million for the wholesale division. Subtracting net debt of ~$1,206 million implies a total market value of ~$822 million for the wholesale division. With SVU’s entire market capitalization of ~$842 million based on its last closing price, evidently the stock market regards the retail division and owned real estate portfolio as immaterial in value.
Unlocking Real Estate Value
SuperValu accounts for the value of owned property on its balance sheet at cost, but a fair value estimate can be derived by making some simplifying assumptions related to the real estate the Company owns. After accounting for the divestment of the DCs and Discontinued Retail Stores, SuperValu is estimated to own ~10.6 million sq. ft. of DC space and ~1.8 million sq. ft. of retail space. One way to estimate the value of this real estate is to rely on conservative price/square foot assumptions of the space owned by the Company. The sale-leaseback deal for the eight DCs indicated a value of ~$81/sq. ft. of DC space - which, for the sake of simplicity, can be applied to the remaining DC real estate. Note that this is a lower value than the $93/sq. ft. estimate put forward by Blackwells based on their research.
For the retail stores, Blackwells has published a list of 18 comparable retail store transactions which indicates an average price of $170/sq. ft., with the lowest and highest transactions between $40 and $473 per sq. ft. (both appear to be outliers). Selecting a lower-than-average estimate of $100/sq. ft. of retail space helps incorporate a margin of safety into this analysis. (Note: Although I have selected prices per sq. ft. that are much more conservative than Blackwells’ estimates, I would put strong weight on the accuracy of Blackwells’ assumptions in this case; Blackwells’ Managing Partner, Jason Aintabi, has a solid background in real estate investing from his prior experience leading Jesta Group, a Canadian family office that has historically focused on real estate deals.)
Applying the selected price points above to the current real estate portfolio yields values of ~$856 million and ~$177 million for the owned DCs and retail stores, respectively. This implies a value for the entire real estate portfolio of ~$1,033 million. For added perspective, Blackwells’ research indicates SuperValu can generate ~$989 million and ~$301 million for the remaining DCs and retail stores, respectively, for a total of ~$1,290M.
At this point, it’s uncertain how much of the owned real estate SuperValu’s management will actually monetize. On the one hand, management has indicated that they are evaluating all of their owned real estate for potential sales, but on the other hand, the language in the Company’s Strategic Initiatives and Reorganization plan (discussed below) appear to focus on selling retail real estate. Erring on the side of caution, this analysis assumes that the Company only sells its remaining retail real estate. Given this assumption, SVU stands to add between $177 million to up to $301 million (Blackwells’ estimate) in market value. Ignoring transaction costs and taxes, this translates to $4.61-7.83 per share, giving us a target share price for SVU between ~$26 and $29 in a conservative scenario. Based on SVU’s last closing price, our analysis indicates a 21-36 percent return for shareholders.
Catalysts
The latest proxy statement includes a proposal to reorganize SuperValu into a holding company (“Reorganization”) which is intended to create a more simplified structure from which to separate the retail and wholesale operations. It is also believed that this will be a better format for achieving sales of retail assets to third parties. Furthermore, the Reorganization is intended to enable SuperValu to utilize its ~$300 million in capital loss carryforwards. However, if a strategic transaction is not achieved by February 2019, then these tax benefits will expire worthless.
Other catalysts on the horizon include the further divestment of real estate and potential transactions involving either the retail division or the wholesale division (possibly both). Should Blackwells gain control of the Board in August, shareholders will likely see aggressive pursuit of all of these initiatives. In April 2018, SuperValu announced that it was working with advisors to pursue strategic alternatives, including a possible sale of the Company. With all of these wheels in motion, there is a strong possibility that one or more of the above catalysts will help unlock material shareholder value within the next 12-24 months.
Risks
Shifting consumer preference towards e-commerce and away from brick-and-mortar retailers puts competitive pressure on all traditional grocers. In particular, Amazon’s (AMZN) acquisition of Whole Foods has increased the uncertainty faced by SuperValu and its peers. This has prompted grocers to increasingly invest in e-commerce capabilities in order to combat the threat (for example, see Kroger’s (KR) deal with UK-based Ocado, an online supermarket). In fact, SuperValu recently announced its entrance into a reseller agreement with Instacart, which will enable online shopping and delivery capabilities to over 3,000 independent retail stores currently supplied by SuperValu across 240 metropolitan areas.
Macroeconomic factors impacting real estate markets will have an impact on the value that SuperValu can ultimately unlock from its real estate. While retail real estate faces ongoing headwinds from growth in e-commerce, the same shift towards online shopping has led to increased demand for industrial real estate (especially warehouses and distribution centers), as e-commerce requires large-scale logistical capabilities to serve widely distributed customers. This dynamic appears to create an embedded hedge for SuperValu’s overall real estate portfolio.
There is a potential risk in SuperValu’s “growth through acquisition” philosophy with respect to its wholesale business. This mentality has historically led many corporate management teams into trouble by overpaying for growth and/or facing unanticipated cost overruns from integration issues with their targets. Also, with the future sales of retail store locations, the wholesale business will lose a portion of its business (as it currently distributes to these retail stores). However, management notes that they’ve factored these losses into their forecasts and believe that any losses will be outweighed by the gains stemming from: a) the sale of unprofitable retail operations, and b) organic growth achieved by the wholesale segment.
Conclusion
Given the sum-of-the-parts value, the hidden value in the real estate, and the currently ongoing review of strategic alternatives, SuperValu stock exhibits a favorable risk/reward profile and has strong potential for price appreciation in the next 1-2 years.
This article was written by
Analyst’s 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. I have no business relationship with any company whose stock is mentioned in this article.
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