Is this Grocer an Attractive Takeover Target?

By Tom Gibbs - June 13, 2012 | Tickers: COST, SWY, SVU, KR, WMT | 0 Comments

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The grocery industry is abuzz thus far in 2012 as discretionary consumer spending has continued to increase and many shoppers begin to emerge from the “emergency saving” habits that have developed over the past several-year recessionary period.  Many of the sector’s primary players – including Kroger (NYSE: KR), Safeway (NYSE: SWY),Wal-Mart (NYSE: WMT), and Costco (NASDAQ: COST) – have enjoyed increasing top lines from mid-recession trough levels as a result of consumers spending more per shopping visit on more discretionary and higher-margin items like premade foods and wines/spirits.

The same cannot necessarily be said about Supervalu (NYSE: SVU), which has perpetually been the industry laggard.  The corporation has experienced an 18% revenue decline and has lost nearly 90% of its stock value over the past five years.  Likewise, with unattractive debt and pension obligation balances, as well as with faltering square footage metrics, Supervalu leaves a lot to be desired. 

Is the grocer an attractive buy-out target, however?  With so much pessimism surrounding the grocery chain and little attention being focused on its rather attractive cash-generating abilities, perhaps Supervalu is now cheap enough to warrant an acquisition by one of the larger and more financially sound players in the field. 

The Plan is There

Supervalu’s primary initiative, especially with comparable store sales declining for the past 15 consecutive quarters, is to begin building some consumer loyalty and store traffic levels.  

Most importantly, Supervalu management has isolated several of the key turnaround points to begin showing some improvement.

• Private Label Focus: Private label brands represented 19.3% of the grocer’s sales in the most recent quarter, which was up 145 basis points from the same quarter in the prior year.  Through continued penetration of private label sales via heightened customer awareness and the addition of new product lines, Supervalu expects an additional 100 basis point improvement per year over the next three years.  Such an improvement in private brand sales will inherently reinforce customer buying habits and simultaneously drive gross margins.
• Every Day Low Prices: Supervalu continues to transition to a Wal-Mart-like every day low price merchandizing strategy, with the goal of building customer loyalty in mind.  Similar to Wal-Mart, the plan should reinforce the notion that Supervalu provides savings across its entire product line, as opposed to the pick-and-choose promotions traditionally used by the competition.  The plan should bode well with the grocer’s core value-focused, and generally less-affluent consumer group.  Recent price reductions of up to 20% on over 200 items have been implemented without a significant hit to gross margins.
• Hyperlocal Strategy: Supervalu has placed a larger emphasis on “fresh” food products and has rolled out locally grown produce displays to build closer ties with its local constituents. 

Wounds are Self-Inflicted

Much of the degradation in Supervalu performance over the past several years can be attributed to a lack of reinvestment into its brand.  Especially when compared to the other competitors in the industry, there has been a noticeable discrepancy in the grocer’s capital spending habits as a percentage of its annual sales:

• Capex/Sales Discrepancy (% difference between Supervalu’s Capex/Sales and the average of Kroger, Costco, and Safeway)
• 2011: 9.4%
• 2010: 16.8%
• 2009: 26.4%
• 2008: 7.7%
• 2007: 13.3%

The corporation has paid down more than $3.2 billion in debt since 2006 in order to free up some funds for an increased investment into the condition of its store base.  A better-funded acquirer would have the ability to speed up the store remodeling process.

Attractive Valuation

Supervalu’s market valuation has depreciated much more quickly than has its cash-generation abilities.  Potential acquirers would not only consider the full purchase price of Supervalu operations (including its debt and pension obligations), but would also put a price on its free cash flow on a square footage basis.  Supervalu is surprisingly in an attractive position when considering these variables. 

Yield is defined as the purchase price of the trailing 12-month cash flow (EV/FCF) divided by the purchase price of the square footage (EV/Square Foot), what the acquirer receives for what it pays.

Supervalu represents the perfect example of an entity whose future rides on a simple dose of much-needed TLC.  The grocer is in possession of significant assets (it owns more than a third of its 2,400+ outlets and controls brand names like Albertson’s and Save-A-Lot), it has outlined a plan to begin turning around its operations, and most importantly, it is a cheap takeover target on a cash-generation basis (even when including its debt load).

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