Is Now the Time to Fill Your Cart with Supervalu?
Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Although not as highly honored as some other professional fields (medicine being an obvious example), the field of investment is no less intellectually stimulating. Nor does the field of investment require any less analytical capacity. At their core both fields, as well as all others, demand the need to make decisions in a complex setting where variables can often change rapidly.
That's why I believe, at least when it comes to investing, dumbing down the decision criteria by focusing only on the most relevant variables to success is critical to avoid all of the noise in the financial markets. Making good investment decisions is not an exact science. Although the principles of stock valuation, such as discounting corporate cash flows to their net present value, is guided by straightforward algebra, the qualitative factors of a stock investment can far outweigh the quantitative intrinsic value of a company’s shares derived by any calculation. One good reason for this is that valuation is not absolute. In most cases, it involves numerous assumptions including growth rates, profit margins, future capital spending, as well as discount rates. Whenever valuation comes into play, I believe there are two universal truths that can dramatically help one to avoid many common pitfalls.
- Building a range of estimates based upon varying situations or assumptions is a good thing
- Base decision upon the most conservative estimate of value
Point number one is a no brainer! However, some might vehemently disagree with point number two. Here’s my perspective: if you use the most conservative estimate of value (meaning the lowest calculated value) and the stock still appears to be a screaming buy when compared to the market price, so long as you haven’t missed something big in your analysis, then the potential opportunity will be that much better. It certainly is possible to miss out on an investment opportunity by applying parameters that are far too conservative in nature, but I would rather risk a missed opportunity than actually suffer real financial loss from overly optimistic or hopeful analysis. Let’s not forget Warren Buffett’s age old advice, “unlike baseball, there is no called strike out in investing.”
With that said, it seems as though major grocery chain operator Supervalu (NYSE: SVU) is being offered up for batting practice with the stock tumbling roughly 40% over the past 10 months. Is now a great time to swing the bat, or should we continue to sit on this pitch?
Supervalu sells food, pharmacy, beauty and related merchandise items under its various store banners including Acme, Albertsons, Jewel-Osco, and Sav-a-Lot, amongst others. The company operates nearly 2,400 stores and has recorded over $36 billion in sales during 2010 fiscal year. In terms of revenues, Supervalu sits well above the industry average competing against industry stalwarts such as Kroger (NYSE: KR), Safeway (NYSE: SWY), and Wal-Mart (NYSE: WMT). However due to a depressed stock price, the company sports only a meager $1.5 billion market cap, which is the shares outstanding times the stock price. This is a mere drop in the bucket compared to industry titan Wal-Mart’s $211 billion market cap.
So why has Supervalu’s stock been beaten so far down over the past several years? Well, increasing competition from both traditional and non-traditional retail chains have helped alongside rising food costs to drive down Supervalu’s margins considerably. The retail grocery industry hasn't been known for exceptional profitability or outsized returns on capital. In fact, Kroger, Safeway, and Wal-mart all have operating margins in the mid single digits and returns on assets ranging in the single digits as well. Seems to be the product of asset-heavy business models in a mature industry. The problem for Supervalu is that it has not been able to compete effectively in these metrics. It also doesn't help when the company overleverages itself with past acquisitions.
But all of this potentially sets the stage as the company is a ripe turnaround candidate. From the perspective of a potentially rewarding investment opportunity, I decided to run Supervalu through a discounted cash flow analysis. Given the company’s massive debt load and weak current earnings, one can only attempt to peer into the future to determine what this stock is potentially worth. Unfortunately, the results do not appear promising. After accounting for continued near-term difficulties, one has to make some lengthy assumptions including ramped up top-line growth, a return to stronger operating margins, and increasing cash flow to cover interest charges on its debt. Only after these assumptions do I derive a value slightly above today’s $6.88 price tag.
It appears as though there is little protection in the current share price despite the stock’s tumultuous fall. This is not to say that the market may not reward the shares in the short run for any positive actions to right the ship. But buying shares on the hope that the market reacts in a certain way is much closer to sheer speculation than investment analysis focused on long-term value creation. This investor has decided to take a page out of Buffett’s playbook by watching this one go by and waiting for a much better pitch!
Motley Fool newsletter services recommend Wal-Mart Stores. The Motley Fool owns shares of SUPERVALU INC. and Wal-Mart Stores. Fool blogger Mike Finaelli has no positions in the stocks mentioned above. 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.