SVU - SuperValu Inc.

[Junto]

Nice job on those $7.50 calls. I'm jealous, I only bought the shares. I'm out at $10. What is your target?

 

My initial target was $12.50 range in 12 months.  I am reassessing my position and target given the most recent information. I am still long both positions.

[ragnarisapirate]

I really like the idea of buying the LEAPS... In fact, I just did.

 

Just look at the improvement to tangible book over the past 3 years, we are basically trading for 3-4x the average... As Myth points out, the beauty of the LEAPS, is that you can use the leverage from the options, to get into a company that is already using a ton of leverage. They are bringing in good people, and these guys can cash flow really well, too. For the risk that seems to be priced into the stock, I am not worried about their debt.

[Junto]

I been purchasing and increasing my position in SVU over the past week. 5%+ dividend yield, positive turnaround developments, and continued good cash flow provides me with extra conviction at these levels.

[Junto]

Good post on SVU dated August 31: http://bit.ly/oIPKsG

 

Investment Highlights

Attractive valuation. The company trades at an EBITDA multiple of 4.5x 2012E EBITDA (according to my estimate), which is towards the low end of the valuation range for SVU (historically between 4-7x). Even though the company is trading at a low price from an enterprise value perspective, based on EBITDA, the real mispricing is in the equity portion of the capital structure. This is evidenced by the forward free cash flow yield of over 37% that the equity trades at.

Significant free cash flow. As mentioned above, the company trades at a very high free cash flow yield, which demonstrates SVU’s ability to generate cash. In addition to making the commitment to fund the aggressive expansion of Save-A-Lot, it has also pledged to pay down its debt aggressively, with $500-$550 million directed towards that effort.

Multiple lines of business. SVU is known for its various supermarket banners; however, it generates very consistent cash flow from its Independent Business segment, which is expected to produce about $243 million in operating income during fiscal year 2012.

Attractive dividend. One of the virtues of the decline of the stock price has been the 4.5% dividend that the stock yields, which SVU can afford as a result of its strong cash flow generating ability. The payout ratio for the company is about 38%.

Significant real estate portfolio. SVU occupies 64 million square feet of real estate. It owns about 38% of that space, which amounts to about 25 million square feet. Based on my calculations, the average rent per square foot that SVU pays, for the leased properties, is approximately $9.7 per square foot. If you assume a capitalization rate of around 10%, then the estimated value of those properties would be around $100 per square foot. Assuming that the quality of owned real estate is similar to the leased real estate, would imply that the 25 million square feet of company-owned real estate is worth approximately $2.5 billion.

Profitable even in a tough environment. Excluding one time write-downs, SVU has been able to remain operationally profitable, even during the recession.

Proactive management. Many articles have been written about Craig Herkert’s (the CEO) efforts to reduce costs in innovative ways. One such example is an article in the Wall Street Journal about how Supervalu has been able to save $4-$6 million annually by increasing the average number of items per bag, thus reducing the number of bags used (in the grand scheme of things those figures don’t move the needle all that much, but it’s an example). Management has been focused on reducing the average item price, but has committed to doing so without hurting the profitability of the company by cutting costs and passing those savings along to the customers. Hence the company expects margins for the year to be flat.

Save-A-Lot. The Company intends to double the number of stores for this banner over the next five years. Save-A-Lot is the fastest growing hard discount retailer in the nation and is a pillar of the Company’s growth strategy going forward.

Debt pay down. The Company intends to pay down $500 to $550 million in financial debt in fiscal year 2011. This is in addition to the $150 million in capital lease payments that are scheduled to be made during fiscal year 2012. SVU has reduced net debt by over $1.7 billion over the last nine quarters (which includes fiscal years 2010 and 2011 as well as the first quarter of fiscal year 2012). This has been made possible as a result of its ample cash flow, as well as the proceeds from selling some assets (such as a logistics subsidiary which was sold for $200 million, and the proceeds of which were applied towards debt pay down).

 

 

[PlanMaestro]

This I did not like.

 

management tempered its expectations for Save-A-Lot store growth for F2012,

 

I would prefer if they just cut the dividend. And they may do that to (buying opportunity)

[ragnarisapirate]

This I did not like.

 

management tempered its expectations for Save-A-Lot store growth for F2012,

 

I would prefer if they just cut the dividend. And they may do that to (buying opportunity)

 

I would love them to cut the dividend...

 

Their present interest payments aren't exactly cheap, and even if they put the money to reducing debt, I wouldn't be unhappy.

 

Regardless, don't want for there to be a dividend. We should both write them letters.

[Arden]

I love the dividend, and wouldn't mind a buyback, but no way no how would I like them to use it to close down debt instead.

They're using a lot of money for opening new stores, there is no reason they can't give back some money to their owners.

 

Everytime I look at it, the Albertsons acquisition just looks more ridiculous, but I think the new CEO is a pretty smart guy (although a little too hyper if you know what I mean :) )

[PlanMaestro]

I love the dividend, and wouldn't mind a buyback, but no way no how would I like them to use it to close down debt instead.

They're using a lot of money for opening new stores, there is no reason they can't give back some money to their owners.

 

Everytime I look at it, the Albertsons acquisition just looks more ridiculous, but I think the new CEO is a pretty smart guy (although a little too hyper if you know what I mean :) )

 

But why are they compromising Save-a-Lot? That is the future. If it is not capital, what it is?

[Arden]

I can't say really, maybe they can't find enough locations or something.. they didn't specify a reason?

[Junto]

Big drop today in SVU does not appear warranted. Mr. Market and me are certainly on different sides on this deal.

 

I have been in and out over that past year with a small core position. Took the opportunity to add to my position today; nearing a full long position, 10% trading portfolio (2.0% overall).

[Arden]

Full position? Full in what way?

[ragnarisapirate]

This is almost getting painful... Something like 1/3 of the shares owned are shorted. The shorts are either brilliant or getting ready to get destroyed- I don't see much middle ground.

[PlanMaestro]

This is almost getting painful... Something like 1/3 of the shares owned are shorted. The shorts are either brilliant or getting ready to get destroyed- I don't see much middle ground.

 

Maybe betting on a dividend cut?

[PlanMaestro]

I'll bite.

 

If there is something that I hate more than a mature retailer is an indebted mature retailer. And worse than a indebted mature retailer, is an indebted mature retailer trying to turn around while facing much stronger competition.

 

But can someone tell me what has happened the last 3 weeks that was not known over the last 3 years?

[collegeinvestor]

It seems significant BV declines are related to their impairment charges.

 

I highlighted something interesting but is there something wrong with their logic. (Perhaps upper-management is comprised of efficient market theorists  >:(?)

 

From the 2011 10k:

 

 

_______________________________________________________________________________________________

The Company undertook reviews for impairment of goodwill and intangible assets with indefinite useful lives twice during the year. During the second quarter of fiscal 2011 the Company’s stock price had a significant and sustained decline and book value per share substantially exceeded the stock price. As a result, the Company completed an impairment review and recorded non-cash impairment charges of $1,840, comprised of a $1,619 reduction to the carrying value of goodwill and a $221 reduction to the carrying value of indefinite-lived trademarks and tradenames within the traditional retail operating segment.

 

The result of the annual review of goodwill undertaken in the fourth quarter indicated no goodwill impairment charges were required. The initial review of goodwill for impairment indicated that the $1,137 carrying value of traditional retail stores’ goodwill exceeded its estimated fair value. Further assessment of the fair value of implied goodwill based on the difference between the fair value of the reporting unit and the fair value of the underlying assets and liabilities did not indicate impairment. Future appreciation of the fair value of the reporting unit assets and liabilities may impact the results of the assessment if similar analysis is required in a future period. The fair value of supply chain services’ goodwill exceeded its $710 carrying value by greater than 5 percent and the fair value of the hard-discount stores’ goodwill substantially exceeded its $137 carrying value. If the Company’s stock price experiences a significant and sustained decline, or other events or changes in circumstances, such as operating results not meeting plan indicate that impairment may have occurred, the Company would reassess the fair value of the implied goodwill compared to the carrying value.

 

[Packer16]

This is the result of managements assessment of a more than temporary decline in value of the firm.  The firm puts together DCF and multiples analyses every quarter when an impairment is expected.  If the stock price stays below the book value by a significant amount over an extended period then an impairment charge is taken on goodwill and some of the intangibles.  These write downs only occur as a result of acquisitions and their related intangibles.

 

Packer

[Junto]

This is almost getting painful... Something like 1/3 of the shares owned are shorted. The shorts are either brilliant or getting ready to get destroyed- I don't see much middle ground.

 

Maestro brings some good points on the leverage front, but I am still adding as people can see in my Covestor Maven portfolio (http://bit.ly/oIIArd) also added some Jan 2014 $5 Calls at $1.95 last week.

 

It is a risk, but one I am comfortable with currently. I like what I am seeing thus far and the debt trades above par (http://bit.ly/HLR2Pv) showing none of the concerns on the equity front. I see a bounce by June but I guess we will see how it plays out.

[ragnarisapirate]

This is the result of managements assessment of a more than temporary decline in value of the firm.  The firm puts together DCF and multiples analyses every quarter when an impairment is expected.  If the stock price stays below the book value by a significant amount over an extended period then an impairment charge is taken on goodwill and some of the intangibles.  These write downs only occur as a result of acquisitions and their related intangibles.

 

Packer

 

At times with this, when the price continues to fall, and I continue to buy more, I keep feeling like I am catching a falling knife! The whole impairment of goodwill Seems like a good way get out of paying taxes... That said, I don't really understand why market price of a security actually has that much to do with the goodwill you carry on the books. I guess that the reason for it is that the market doesn't view the acquisition as being one that will pay for it's goodwill?

 

Also, I believe that there will be a cash infusion from selling off the gas stations will be reported this next quarter (they got the money from what, 1/2 of them last quarter)? That probably means that they are getting ready to open up more sav-a-lots or have a smaller amount of debt (not a ton, but, every bit helps (especially when it is trading above par)!

[enoch01]

This is almost getting painful... Something like 1/3 of the shares owned are shorted. The shorts are either brilliant or getting ready to get destroyed- I don't see much middle ground.

 

Maestro brings some good points on the leverage front, but I am still adding as people can see in my Covestor Maven portfolio (http://bit.ly/oIIArd) also added some Jan 2014 $5 Calls at $1.95 last week.

 

It is a risk, but one I am comfortable with currently. I like what I am seeing thus far and the debt trades above par (http://bit.ly/HLR2Pv) showing none of the concerns on the equity front. I see a bounce by June but I guess we will see how it plays out.

 

What is the argument for a turnaround?  Revenue continues to drop, margins remain thin, and CapEx spending is already low.  I like a panic as much as the next guy (and I am smelling one here), but I can't think of many good reasons to run into this fire.

[ragnarisapirate]

This is almost getting painful... Something like 1/3 of the shares owned are shorted. The shorts are either brilliant or getting ready to get destroyed- I don't see much middle ground.

 

Maestro brings some good points on the leverage front, but I am still adding as people can see in my Covestor Maven portfolio (http://bit.ly/oIIArd) also added some Jan 2014 $5 Calls at $1.95 last week.

 

It is a risk, but one I am comfortable with currently. I like what I am seeing thus far and the debt trades above par (http://bit.ly/HLR2Pv) showing none of the concerns on the equity front. I see a bounce by June but I guess we will see how it plays out.

 

What is the argument for a turnaround?  Revenue continues to drop, margins remain thin, and CapEx spending is already low.  I like a panic as much as the next guy (and I am smelling one here), but I can't think of many good reasons to run into this fire.

 

A lot of the revenue drops (in my mind, anyway) are coming from the turnaround. For example, they are working to sell their own lines of foods, which should decrease SSS as they are generally less pricey than other brands, but, eventually, should increase margins. Additionally, they are closing unprofitable stores- which does decrease the top line.

 

I think what the bond side of things is showing, is that the risk of default is low, but, the equity sellers are betting that they will just have revenue and margin compression until the company doesn't really cash flow. The ironic thing here, is that as the debt gets paid off, their earnings will go up nicely.

[enoch01]

 

I think what the bond side of things is showing, is that the risk of default is low, but, the equity sellers are betting that they will just have revenue and margin compression until the company doesn't really cash flow. The ironic thing here, is that as the debt gets paid off, their earnings will go up nicely.

 

Maybe.  But the bond market could also be responding to the fact that the company is accelerating the paydown.  The problem is, the company is choosing to starve the business (or at least put it on an unhealthy diet) in the process.

 

Any estimate of normalized earnings?

[FCharlie]

 

 

What is the argument for a turnaround?  Revenue continues to drop, margins remain thin, and CapEx spending is already low.  I like a panic as much as the next guy (and I am smelling one here), but I can't think of many good reasons to run into this fire.

 

Does SVU actually need to turn around in order for the stock to do very well here?

 

It would seem that all the equity investor really needs at this price is for the business to stabilize. I don't think that's wishful thinking. We have increasing population, an economic recovery, food price inflation, fuel price inflation (which leads to food price inflation)...

 

SVU investors can do quite well here at $5.50/share

[ragnarisapirate]

 

 

What is the argument for a turnaround?  Revenue continues to drop, margins remain thin, and CapEx spending is already low.  I like a panic as much as the next guy (and I am smelling one here), but I can't think of many good reasons to run into this fire.

 

Does SVU actually need to turn around in order for the stock to do very well here?

 

It would seem that all the equity investor really needs at this price is for the business to stabilize. I don't think that's wishful thinking. We have increasing population, an economic recovery, food price inflation, fuel price inflation (which leads to food price inflation)...

 

SVU investors can do quite well here at $5.50/share

 

I totally agree with this. In regards to normalized earnings, I have no idea what they will be. BUT, I do know that when something is trading for under 3x it's previous 3 year's average of the increase of tangible book value, that it strikes me as freakishly cheap. Granted, there are other things to consider, but, that metric is the easiest for me to say off the cuff. ;)

[enoch01]

 

 

What is the argument for a turnaround?  Revenue continues to drop, margins remain thin, and CapEx spending is already low.  I like a panic as much as the next guy (and I am smelling one here), but I can't think of many good reasons to run into this fire.

 

Does SVU actually need to turn around in order for the stock to do very well here?

 

It would seem that all the equity investor really needs at this price is for the business to stabilize.

 

Right, that's the turnaround.  Will it happen, that is the question.

 

I don't think that's wishful thinking. We have increasing population, an economic recovery, food price inflation, fuel price inflation (which leads to food price inflation)...

 

These are very prosaic, macro-oriented observations, which if true, probably apply across the entire industry.  So the question remains: why will SVU be able to stabilize the business in the face of less leveraged competition that arguably operates more efficiently (I'm thinking of Wal-Mart, for example).

 

SVU investors can do quite well here at $5.50/share

 

Care to share any estimate of normalized earnings?

[bmichaud]

I hate to pull a Burke CEO and comment ad infinitum on other investors' positions that I have no position in, but since I've had the unfortunate experience of being a long and short investor in this POS, I'm going to take a stab at how I would look at it.

 

This thing is in secular decline at worst, and barely treading water at best. Competition is outrageous, margins are declining, pricing power is non-existent, thus the current total debt to EBITDA ratio of 3.6 times is unsustainable. They are in a virtuous cycle of needing to reinvest back in the business but also pay down debt. So....

 

The way I would look at is in a pro forma scenario where they have to issue equity, then from there I would estimate normalized EPS.

 

Right now total debt is 6.9b and ebitda is 1.9b. I'd say a more sustainable td/ebitda ratio is say 1.5 times. to achieve that, they'd have to reduce debt by 4.05b. If they did that via an equity issuance at $5.50 per share, that's an additional 736 million shares added to current shares of 212 million. So then "new debt" is 2.85b - let's say the "new interest rate" is 6%, that means "new interest expense" is 171 million. LTM ebit is $1 billion, so "new EBT" is $829 million (1,000 - 171). Assuming a 35% tax rate, "normalized net income" is $539 million, or $.57 per share (948 million shares out).

 

So a "no growth" valuation would perhaps be 10 times $.57 per share, or $5.70 per share. I think someone said the real estate is another $2 billion, so that's another say $2.11 per share for an all-in fair value of $8.00 per share.

 

Free cash flow available right now for debt paydown is probably around $500 million, which means it would take 8 years for them to reduce the $4 billion of debt down to 1.5 times ebitda, and that assumes ebitda does not continue to decline, a highly unlikely proposition.

 

Obviously the above analysis can be manipulated ad nauseum, but at current levels I just don't see the margin of safety at these seemingly attractive PE multiples given there is next to zero balance sheet protection.

 

IMO, a stock wouldn't be this heavily shorted if there weren't serious fundamental issues. SHLD, NTRI, RSH, TLB, SVU have all eventually succumbed to the weight of their own deteriorating business models. SHLD is quite the exception given the activism at hand in the stock.

 

As with any "deep value" play, this very well could double from here for one reason or another. I just don't see how, from here, it passes the test of would you be comfortable owning it for five years if the stock market shut down. Between reinvestment just to maintain the business, margin erosion, and debt repayment, I don't see the return over the next five years were the market to shut down. Much better opportunities out there, IMO....