SuperValu May Be Too Far Gone To Save

By Stephen D. Simpson, CFA | July 13, 2012 AAA

Food retailing has never been an easy business, particularly since large discounters like Walmart (NYSE:WMT) and Target (NYSE:TGT) got into the game in a big way. While there has been room for companies with differentiated models (often built around premium products or intense merchandising skill), SuperValu (NYSE:SVU) has been struggling to differentiate itself and compete effectively in the mainline supermarket space. With this major earnings disappointment in hand, it's worth asking if even deep-value turnaround investors ought to bother with this name.

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A Miserable to Start to the Fiscal Year
There had been a few halting signs of progress in SuperValu's multi-year turnaround strategy, but first quarter results were a disappointing step back to the bad news.

Revenue fell 5% this quarter, with sales in the retail food group down almost 7%, sales from the hard discount Save-A-Lot business up 1% and supply chain sales down about 1%. Retail comps were quite disappointing at negative 3.7%; down almost two additional points from the prior quarter and well short of consensus expectations around 2%. Save-A-Lot comps were down 3.4% as well.

SuperValu also saw negative margin trends despite ongoing attempts to fix its cost structure. Gross margin fell slightly, due to a host of factors including marketing costs and theft ("shrink"). Operating income plunged 25%, and the company missed sell-side earnings estimates by a substantial margin.

SEE: Understanding The Income Statement

Save-A-Lot Doesn't Seem Like the Crown Jewel Some Thought It Was
Arguably the most disappointing part of the SuperValu story today is the poor performance of Save-A-Lot chain. Management tried to blame the weak results on increased stress in its core customer base, but I'm not buying this.

Most government economic data suggests that conditions are getting better in this segment, and deep-value retailers like Family Dollar (NYSE:FDO) aren't having the same problems. More likely, companies like Aldi are chewing into Save-A-Lot's core markets, but management has a vested interest in casting the blame elsewhere if they want to sell or spin off this business.

How Many Alternatives Are Left?
That leads directly into the next major development with this earnings release - management's acknowledgment that it is exploring "strategic alternatives". Since SuperValu is really more like three businesses in one, this is a logical move to consider. Even if Save-A-Lot is not strong right now, I could see private equity being interested in this business, as well as the grocery distribution business.

SEE: What Is Private Equity

While selling businesses could certainly raise cash and ease some liquidity issues, it doesn't really help the long-term survivability of the parts. In the retail business, for instance, management has elected to accelerate its on-the-shelf price-cutting ahead of the pace of cuts in store operating expenses.

Unfortunately, I don't think this is a game that SuperValu can win. Kroger (NYSE:KR) and Safeway (NYSE:SWY) will fight hard to maintain their businesses and are likely in better position to win a war of attrition. Likewise, with Walmart pushing on with their urban store formats, SuperValu could find its leading share in multiple major urban areas under attack.

The Bottom Line
I love a good turnaround story, but I just don't see one here at SuperValu. Instead, I see a company that has been in perpetual turnaround for multiple years, but without really changing the business in a meaningful way. I don't believe that SuperValu can win on price, and I don't believe the company has the resources, time, or vision, to create a truly differentiated store concept along the lines of Fresh Market (NYSE:TFM) or Trader Joe's. Accordingly, I just don't see a compelling reason to own these shares today.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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