It's Just A Matter Of Time

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

This might sound judgmental and I wish I could say I'm sorry, but for SuperValu (NYSE: SVU) investors it's just a matter of time. The company's recent results show a company in trouble. On the surface, the company is saying all of the right things. However, I think it's possible this sinking ship is past saving. There is an industry shift in the grocery business that SuperValu is facing, and unfortunately this shift is likely to lead to the company's demise.

Squeezed From All Sides:

The grocery business was already cutthroat and even successful grocers survived on very thin margins. However, there are two strategic shifts that have already occurred to divert shoppers away from traditional grocery stores. First, there is a rise of organic competition that is growing fast and taking business from regular stores. A great example is Whole Foods Market (NASDAQ: WFM). The company operates less than 500 stores, and has been growing by leaps and bounds. Analysts expect EPS growth over the next few years of better than 17%, and the company may even beat these expectations. Whole Foods plans on speeding up their new store growth over the next few years, and is already generating free cash flow. Second, grocery stores aren't as convenient as they used to be. Increasingly customers are looking for a one stop shop to get all of their shopping done. Which company is better positioned to take care of this need than Wal-Mart (NYSE: WMT)? No matter what regular grocery stores believe, the fact that Wal-Mart can beat their pricing on many items, and also offer thousands of items you'll never find at a grocery store, is a huge competitive advantage. Before Wal-Mart and Target began offering produce, deli, and frozen goods, it wasn't uncommon for our household to make a trip to Target or Wal-Mart to buy certain items, then make a trip to the grocery store for specific items. Now that we can get everything from just Wal-Mart, it doesn't make sense to make a separate trip to the grocery store. This is happening millions of times over across the country and is leading to tougher competition for the traditional grocery chain.

Headline Earnings:

In SuperValu's recent quarter, revenue was down 4.76% and adjusted EPS was down to $0.00 from $0.28 last year. The company cited four strategic initiatives for future growth, but there is really one initiative and that is to produce enough cash flow to survive. One comment from the report that rang hollow to me was the CEO Wayne Sales comment that, “I am pleased that the Company continues to generate substantial cash flow.” Looking at the results, I guess he and I have different definitions of “substantial.”

3 Divisions And Not Much Positive:

The bottom line is, for SuperValu to survive they have to turn around their Retail Food division. This unit represents 64.65% of total revenue and the numbers are just not good. Revenue was down 7.3% driven in part by a decline of 4.3% in same store sales. It's hard to be encouraged by the fact that the company generated $59 million in earnings when last year this division generated $127 million. This decrease of 53.54% in income is bad enough, but when you consider that the company generated this $59 million in earnings on $5.2 billion in sales, you can see how difficult this environment is for SuperValu. Just to give some perspective, the company's Save-A-Lot division reported revenue of $973 million and operating earnings of $34 million during the quarter. Think about that for a minute, the Retail Food division had 534% more in sales, yet generated just 73.5% more profit. Speaking of Save-A-Lot, the company's most promising unit grew revenue by just 0.1%, and same-store sales were down 3.7%. In addition, the previously mentioned $34 million in income was down 32% from last year. The company's Independent Business sales were up 1.1%, but operating income from this division decreased more than 10%.

Financials = Yikes!
It's hard for me to look at SuperValu's financial statements. Maybe the clearest picture of SuperValu's struggles can be found in their operating margin. Even if you adjust for one-time items, the company's op. margin was just 0.41%. By comparison, companies like Whole Foods and Wal-Mart show op. margins of 6.9% and 5.86% respectively. Even if you look at more traditional grocers, Kroger (NYSE: KR) and Safeway (NYSE: SWY) show better margins than SuperValu. Kroger reported an op. margin of 2.46%, and even the struggling company Safeway showed a margin of 2.17% in their most recent quarter. Even excluding all of SuperValu's other expenses, the company saw compression in their gross margin as well, which dropped from 22.2% last year to 21.4% this year. What is really scary though is the company's cash flow. On a year-over-year basis, operating cash flow dropped by 28.45%. Even more disconcerting is, since February of this year, the company's balance sheet has gotten worse. In fact, the company's cash balance is down $9 million and long-term debt has increased by nearly $200 million. While the company did produce $71 million in free cash flow, it's too ironic that this was primarily due to the $71 million in income tax benefit the company claimed. Without this benefit, the company would have reported $0 free cash flow.

Conclusion:

SuperValu's outlook called for debt reduction of $400 - $450 million. Here is the problem; the company has already run up almost $200 million in new long-term debt in just the last eight months. In addition, without the company's income tax benefit there would have been no free cash flow to use to pay down debt in the current quarter. Though I've made the comparison of SuperValu to Safeway before, even this struggling grocer looks like a better value at this point. Safeway sells for a P/E of about 8, is expected to grow by 9.6%, and the company's dividend of 4.28%, if sustainable, would be a good reason to buy the stock. When you consider that Safeway's op. margin is over five times that of SuperValu, there is no question that Safeway is in a better position. If investors want an even better option, Kroger looks like a good value at these prices. The company pays a dividend of about 2.4%, and the company is much more diversified than SuperValu. Kroger operates not only its supermarkets, but also 791 convenience stores, and 348 fine jewelry stores. The two best plays in the grocery industry at this point appear to be Whole Foods and Wal-Mart. Both companies lead their categories in the organics and general merchandise. While neither company is what I would call cheap, buying either stock avoids the biggest risk to SuperValu investors, which is that of bankruptcy. If SuperValu can't produce real free cash flow and continues to see declining earnings, bankruptcy is a real possibility. I'm sorry SuperValu investors, but it's probably just a matter of time.


MHenage 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, Whole Foods Market, and Wal-Mart Stores. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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