Don't Buy The SuperValu Dip

| About: SUPERVALU Inc. (SVU)
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It may seem appealing to purchase shares of a company that are trading at $4 that once traded that once traded at $50, but resist the temptation. Based on Supervalu's (SVU) most recent quarterly report, investors need to remain on the sidelines until signs of optimism appear. Here are the reasons why.

  • While shares might appear inexpensive on a price/free cash flow basis, they are not cheap on an enterprise value/cash flow. If the company continues its current earnings trajectory for the remainder of the year, shares trade at about 15x EV/ Free cash flow. That is far from a deal for a company who has not seen a year over year increase in sales for more than three years.
  • In the company's most recent quarterly earnings release, one of the highlights includes accelerating price investments, which is another way to say that they are lowering prices. Whenever investors are holding shares of a supermarket chain, the biggest fear is always price deflation, as the fixed cost for the business are fairly high and the margins are low. Even Whole Foods (WFM) fell victim to this in the Great Recession, but they managed to turn the ship around. For a company with low single digit operating margins, every little tenth of a percent makes a big different on the gross margin. There's little evidence to suggest, by the way, that lowering prices will bring in new business.
  • In one quarterly results report, the company managed to suspend its dividend, which has been in place since 1985, and announced that it was exploring strategic alternatives. The removal of the dividend makes sense, as the company has to set a priority of improving the balance sheet. Exploring strategic alternatives at this time is coming out of a position of weakness and should be taken cautiously. While its always possible there will be bidders for the company, it is unlikely given the continuing deteriorating performance, legacy liabilities and questionable valuation. Additionally, the company has no tangible book value.
  • None of the companies businesses are stable. Operating earnings declined in all three business units. While Save-A-Lot is supposed to be the company's outperformer, its operating earnings were down 15% year over year, in spite of increased sales. Same network sales at Save-A-Lot stores declined 3.4% in the period.
  • Despite the stock being below $5 for 2 months, there have been no insider purchases since the beginning of the year. On a net basis, there has only been 30,000 net shares purchased in 2012. If insiders bought shares in the millions of dollars, that could be a signal that they are optimistic on the company's prospects.
  • Competition, both on price and quality, continues to be fierce. Whole Foods, WalMart (WMT), Target (TGT) and even dollar stores including Dollar General (DG) compete fiercely, albeit in different ways, for share of the retail food market. For WalMart and Target, it is not very difficult for them to increase the size of their stores to accommodate the supermarket. Additionally, even though they are competing on price, many of the stores are aesthetically pleasing. On the other end of the spectrum, while many of Whole Foods items are on the high end, it has increased share of its lower priced items as a % of overall sales.
  • It is entirely possible that the economy is headed into another recession in the second half of 2012 going into 2013. If investors work on the assumption that private equity, still hung over from 2008, has learned anything, they likely will not be so bold as to make a $10 billion purchase of a business with price deflation and deteriorating fundamentals.

There is room for upside if the company posts a profit and shows that it can grow profitably in the coming quarters. But for all of the reasons I laid out, that is unlikely. Additionally, shares would react positively if the company was purchased, however, that is also an unlikely scenario. If investors want to gamble on this stock, they should likely wait for a lower price.

Disclosure: I am short WFM.