Can Supervalu Survive?

Dr. Osman is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Supervalu (NYSE: SVU) is one of the oldest wholesale and retail food stores in North America. Established in 1871, the company survived several worldwide recessions. However, Supervalu has been going through tough days, recently. It is losing market share due to intense competition in the business. The stock lost almost 60% in this year alone. Although the stock looks like a bargain at the current prices, I am not sure whether it is a good stock to invest now. In this article, I dig deeper into the company’s recent financials and -more importantly- into the debt issue to prove my point.

Second Quarter Results

At the end of second quarter, Supervalu's net sales stood at $8.0 billion in comparison to $8.4 billion last year. The fall in sales was primarily due to the disposition of retail fuel centers and the decline in identical store sales. Identical store sales were affected by the distressed consumer, and ongoing investment in obtaining competitive pricing. The company produced gross profit of $1.72 billion, or 21.4% of net sales. However, in the same period, last year, the company produced gross profit of $1.87 billion or 22.2% of net sales. The decline in gross margins may be a warning signal. The gross margin has reduced primarily due to promotional activities and increased level of competitive pricing.

At the end of second quarter, retail food operating earnings stood at $59 million, or 1.1% of net sales. The retail food segment generated net sales of $5.20 billion in comparison to $5.61 billion the previous year, a decline of 7.3%. The decline primarily reflects the reduction in identical store sales. The company's operating margin from retail food also went down by almost 50%. Now that is another warning signal. The retail food segment forms the backbone of Supervalu’s business model, and the profit reduction in this segment can be highly costly to the company and shareholders.

A relatively small portion of sales came from the Save-A-Lot segment. Sales in this segment stood at $973 million which is slightly higher than the previous year. However, operating earnings dropped to $34 million compared to $50 million in the previous year quarter, which is also another red flag.

Cash Flows

It is pleasing that the corporation continues to produce substantial cash flow. In the first half of 2013, Supervalu generated cash flows from operating activities of $415 million. However, this represents a sharp decline of $165 million. Cash flows used from investing activities stood at $307 million in comparison to $203 million last year. The increase in investing activities was due to higher payments for capital expenditures.

Supervalu needs cash at the moment, and the company is estimated to generate $950 million in cash flow through the end of fiscal year. Supervalu will also likely gather cash from the proceeds of asset sales. The company might also issue additional debt as it generated about $117 million of cash flows from financing activities in the second quarter.

Debt Issue

Supervalu has been battling with huge debts. Presently, the debt situation is extremely serious, specifically in comparison to the industry average. The company has about $6 billion of long term debt and lease obligations. In the first quarter of this year, Supervalu managed to complete two debt financing deals, totaling $2.5 billion. This credit facility gives the company better financial flexibility, aiding it to roll off current debts. Thus, despite current challenges, the company is taking positive measures to resolve the situation. Supervalu currently expects debt reduction for financial 2013 to be in the range of $400 to $450 million. Capital expenditure are forecasted to be in the range of $450 to $500 million.

Competition

<table> <tbody> <tr> <td> <p><strong>Figure in Million</strong></p> </td> <td> <p><strong>Net Income</strong></p> </td> <td> <p><strong>Long term D/E</strong></p> </td> <td> <p><strong>Operating Margin %</strong></p> </td> <td> <p><strong>Beta</strong></p> </td> </tr> <tr> <td> <p><strong>Supervalu</strong></p> </td> <td> <p>-1244</p> </td> <td> <p>Very High</p> </td> <td> <p>-2.41</p> </td> <td> <p>1.16</p> </td> </tr> <tr> <td> <p><strong>Kroger</strong></p> </td> <td> <p>728</p> </td> <td> <p>1.8</p> </td> <td> <p>1.61</p> </td> <td> <p>0.37</p> </td> </tr> <tr> <td> <p><strong>Whole Food Market</strong></p> </td> <td> <p>465</p> </td> <td> <p>0.001</p> </td> <td> <p>6.36</p> </td> <td> <p>1.03</p> </td> </tr> <tr> <td> <p><strong>Safeway</strong></p> </td> <td> <p>523</p> </td> <td> <p>2.3</p> </td> <td> <p>2.37</p> </td> <td> <p>0.77</p> </td> </tr> </tbody> </table>

  Source: Finviz.com

Supervalu's main industry peers are Safeway (NYSE: SWY)Kroger (NYSE: KR), and Whole Food Market (NASDAQ: WFM). Supervalu generated a steady gross margin of 22.21% in 2012 and 22.41% in 2011. However, the company is a loss-maker and it produced negative earnings in the previous year. Safeway, Kroger and Whole Food Market generated operating margins of 2.37%, 1.61%, and 6.36%, respectively. It is clear from these gross margin numbers that the grocery industry has very slim operating margins on sales.

It also seems that Supervalu is struggling with insufficient growth in its operating activities. The corporation's operating income fell for fiscal 2012. Furthermore, Supervalu is susceptible to financial leverage as it took on a new $2.5 billion of debt in the last quarter.

Foolish Summary

Supervalu continues to lose market share and underperform its industry peers. The purchase of Albertson's doubled the company's supermarket base, which now works under twelve different banner names. The management also launched a number of initiatives to reverse market share losses, which so far have been unsuccessful in the face of industry headwinds.

According to government data, the traditional grocery channel has dropped nearly 20% market share to wholesale clubs and supercenters during the last quarter century. Therefore, the firm has a very high fair-value uncertainty rating. It is unfortunate for the shareholders that Supervalu has not developed an economic moat to protect its market share. It is also very likely that the trend of the food market share shifting to supercenters and wholesale clubs will continue over the next decade. Whether Supervalu can survive this trend or not brings substantial uncertainty to the company's future prospects.


ecofinstat has no positions in the stocks mentioned above. The Motley Fool owns shares of Supervalu and Whole Foods Market. Motley Fool newsletter services recommend Supervalu and Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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