It's Finally Time to Buy This Retailer
Ted is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Note: A previous version of this article incorrectly stated Supervalu's market capitalization and enterprise value. The error has been corrected.
Supervalu (NYSE: SVU) has taken shareholders on a wild ride over the last few years, but it is finally positioned to create lasting value for investors.
The company had historically been a grocery chain and a wholesaler to independent grocers. However, it completed a leveraged buyout of Albertson's in 2006, which left it with no financial flexibility during the recession. As a result, the company lost significant market share and its margins were crunched.
In January, the company announced the sale of Albertson's to Cerberus Capital Management, a New York-based hedge fund. As part of the deal, Cerberus agreed to make a tender offer for 30% of SVU's shares outstanding. The hedge fund was also allowed to appoint a new chairman and a new CEO.
As part of the restructuring, SVU will now consist of its original grocery chain, its wholesale operation, and its dollar store-type format Save-A-Lot. This new model positions Supervalu to take advantage of upward trends in wholesale and dollar store formats and shifts it away from the declining supermarket business.
In addition to the Albertson's stores, Cerberus also agreed to take on the associated debt. This shores up Supervalu's balance sheet so that it can accelerate Save-A-Lot store openings and have financial flexibility in the event of another downturn.
Management's comments about pro forma EBITDA are encouraging. The company estimates 2013 EBITDA at $750 million and 2014 EBITDA approaching $800 million. Most of the increase in EBITDA is expected to come from cost cutting rather than revenue growth.
An investment in Supervalu hinges on the success of its Save-A-Lot concept. The format has shown promise, but it operates in an intensely competitive environment.
Dollar General (NYSE: DG) and its compatriots have a foothold in the ultra-value small store format. Dollar General has substantial growth plans that involve rolling out new stores across the U.S. In addition, the company is near an all-time high in profitability due to operational efficiency. As a result, the company is well-positioned for another recession -- same-store sales and profit margins actually expanded during the last recession. It will be difficult for Save-A-Lot to steal share from this experienced competitor.
As if the traditional hard discount operators were not competition enough, Wal-Mart (NYSE: WMT) is rolling out its own dollar store format. The company's current plans call for 700 to 800 Neighborhood Market stores. Considering Wal-Mart's enormous free cash flow engine, investors can count on Wal-Mart spending a lot of money on this concept -- whether it shows initial promise or not. This will make things tough for Save-A-Lot.
However, if Save-A-Lot is able to meet management's expectations, then the stock is wildly undervalued. The company's market capitalization is about $932 million. After accounting for the Cerberus transactions and adding in pension liabilities, the total enterprise value comes out to $7.5 billion.
Although the Cerberus transaction offloads a lot of debt, Supervalu is still highly levered. This leverage is why only a small re-pricing of the enterprise has such a drastic effect on the value of the equity. This is a source of major upside potential, but it is also a source of downside.
Supervalu is doing the right things to get its business going again. If management can hit its targets, then Supervalu can easily triple from here. But always be aware of the downside.
Ted Cooper has no position in any stocks mentioned. The Motley Fool owns shares of Supervalu. 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!