After a Good Quarter, Is the Transformation Taking Root at SUPERVALU?

Regional grocer SUPERVALU impressed Mr. Market with its latest financial update, a better-than- expected report that led to a subsequent pop in its share price. Is it time to bet on the company?

Jun 6, 2014 at 9:30AM

Regional grocer SUPERVALU (NYSE:SVU) took its tough medicine last year, agreeing to offload most of its traditional grocery store banners to private equity firm Cerberus, a deal that allowed it to eliminate a big chunk of its debt load. While the company's results have been up and down since then, SUPERVALU seems to be on the right track, even going so far as to troll for potential acquisitions, as it tries to compete with larger sector players, like Wal-Mart Stores (NYSE:WMT).

SUPERVALU's latest financial update was another positive data point, as it reported better-than-expected profitability, leading to a subsequent pop in its share price. So, at current levels, is SUPERVALU a good bet?

What's the value?
SUPERVALU is one of the nation's leading grocers, operating a retail network of roughly 1,500 stores, mostly under its value-oriented Save-A-Lot brand. It also has a major presence in the grocery wholesale business, distributing products to more than 1,800 independent stores in 42 states. While the wholesale segment has notoriously razor-thin margins, it piggybacks off of SUPERVALU's existing distribution network infrastructure, theoretically allowing the company to enhance its overall profitability.

In its latest fiscal year, SUPERVALU posted improved financial results, highlighted by a 21.6% increase in adjusted operating income. Despite an underwhelming top-line gain, up just 0.1%, SUPERVALU's core Save-A-Lot segment seemed to anecdotally turn the corner, reporting a positive comparable-store sales performance for the period. More importantly, SUPERVALU remained net cash flow positive, providing the solid financial foundation necessary to pursue its long-term growth ambitions.

Out of the infirmary, into the frying pan
Now that SUPERVALU is out of the infirmary, the question is whether it can continue finding its way to higher profit growth. Unfortunately, accomplishing that task seems like it is going to be a tough slog, given the like-minded growth ambitions of its competitors.

Ironically, one of those major competitors is Cerberus, the aforementioned buyer of SUPERVALU's non-core grocery banners last year. That deal, though, was just a prelude to Cerberus' latest gambit, the acquisition of regional grocery chain Safeway (NYSE:SWY), a transaction that more than doubled its store network, adding a significant presence in the Western U.S.

In addition, Cerberus gained control of Safeway's manufacturing network through the transaction, including 20 plants in the U.S., which should allow Cerberus' grocery banners to upgrade their product offerings in the private-label arena.

Of course, SUPERVALU's biggest competitive threat is undoubtedly Wal-Mart, the nation's largest grocer with an unrivaled base of more than 4,800 stores in the U.S. Despite a lackluster year in 2013, evidenced by declines in comparable- store sales and operating profit, the company is ramping up its capital spending in the current year, with plans to increase the footprint of its Neighborhood Market brand. 

More importantly, Wal-Mart's prodigious operating cash flow, $23 billion in its latest fiscal year compared to $120 million for SUPERVALU, gives it the freedom to engage in so-called price investment, making life more difficult for smaller competitors that are aiming to compete in the value-price arena.

The bottom line
SUPERVALU has a new lease on life, thanks to management's decision to sell its underperforming grocery units, a wise move that vastly improved its balance sheet. That being said, the company's rightsizing transformation has it focusing on a value-conscious customer base in its retail operations, via its Save-A-Lot brand, a tough place to play, given the size and strength of its primary competitors.

Indeed, after a lackluster year, Wal-Mart is upping its planned capital expenditures, especially in its small-format Neighborhood Market segment, a strategy that is certain to increase the competitive pressure on everyone else, given Wal-Mart's stated desire to be the low-cost provider in each of its markets. As such, investors should be watching the story unfolding at SUPERVALU, but they should probably do so at a distance.

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Robert Hanley owns shares of Supervalu and Safeway. The Motley Fool has no position in any of the stocks mentioned. 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.

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