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What if I told you that you could buy a stock trading at five to six times this year's earnings (cheap!), paying a sizable dividend, and being led by industry-veteran managers? Even better, this small-cap company has a clear opportunity to accrue massive value to shareholders, and it's already beginning to see results. The Motley Fool Hidden Gems team handpicked this stock late last year and then added it to the service's real-money portfolio.

You don't find stocks trading at single-digit P/Es without some issues, or at least Mr. Market's thinking that something's wrong. And that's the case here. Although this company operates in a tough industry with waifish margins, it is solidly profitable. It owes a lot of money, but has committed to paying down its obligations with its hefty cash flow. Still, the stock is approaching its five-year lows, so it must be a dog with fleas, right?

Wrong. Mr. Market isn't giving this company -- SUPERVALU (NYSE: SVU  ) -- a fair shake. Here's why.

This company lives up to its name
You might not know SUPERVALU by name, but there's a decent chance you've been in one of its stores -- Jewel-Osco, Albertson's, Shaw's, and Save-A-Lot, to name a few. The company's 2,500 stores dot the U.S. and provide the usual assortment of grocery items.

The grocery business is tough, with traditional players such as Kroger (NYSE: KR  ) , Safeway (NYSE: SWY  ) , Publix, and others running solid operations. In the past decade or so, nontraditional players such as Wal-Mart (NYSE: WMT  ) have moved into the space in a big way, followed more recently by Target (NYSE: TGT  ) and Walgreen (NYSE: WAG  ) , which are looking to attract grocery shoppers, who are known for providing regular traffic, to their stores in order to get them to buy nongrocery products while there. Even deep discounters Dollar General (NYSE: DG  ) , Family Dollar, and Dollar Tree are appealing to bargain-conscious food shoppers.

That type of competition thins out the operating margins at traditional grocers, as you can see by the meager numbers below:





SUPERVALU 2.7% 3.2% 3.2%
Kroger 2.7% 2.9% 2.9%
Safeway 3.0% 3.5% 3.5%
Ruddick 4.5% 4.0% 4.0%

Source: Capital IQ, a division of Standard & Poor's.

Despite these low margins, SUPERVALU is projecting earnings of $1.20-$1.40 per share for the year, putting its forward P/E at just 5-6 times. That compares to P/Es of 9-15 times for traditional peers. SUPERVALU's first quarter saw earnings clock in at $0.35 per share.

The turnaround
The company's operating performance has lagged peers' recently. But under recently installed CEO Craig Herkert, an industry veteran from Wal-Mart, SUPERVALU has moved to right the ship. Here are just a few of the ways.

The company is working to increase the perception of its products as good value. SUPERVALU is creating a store brand that will span its store base, replacing the various store brands that already appear in its locations. Such brands provide higher margins for grocery stores, but they comprise just 19.3% of SUPERVALU's sales, well below peers. The company is working to increase that penetration by one percentage point annually over the next three years to get back in line with rivals.

The company is also allocating capital more efficiently, throwing money behind its hard-discount chain Save-A-Lot, which is seeing strong results. Save-A-Lot offers prices that run 13%-17% less than discounters'. Expanding that chain requires relatively little capital, since SUPERVALU licenses about 70% of its stores, but provides high-margin revenue. The company plans to open some 210 Save-A-Lot locations in 2011. It's also refraining from expanding its traditional grocery outlets and even exiting unprofitable markets.

In order to differentiate its offerings and respond to varying local preferences, the company is focusing on hyperlocal products, trying to source products from nearby areas.

Massive value creation
So the business looks cheap and things seem to be turning, but where's this massive value creation I was talking about? The company has committed to deleveraging, using its substantial operating cash flow to pay down its debt. SUPERVALU's takeover of Albertson's in 2006 piled $7 billion in debt onto the company, and the stock has cratered since then -- down from $45 in 2007 to just $7 today -- as huge interest charges and investor concern weighed on shares.

But since early 2008, the company has pared debt by $1.8 billion, or 21%. That has dropped interest charges by 26%, to $535 million over the past four quarters. The company reduced debt by $722 million last year and has promised to pay off another $500 million to $550 million this year.

While the company still does have debt of $7 billion, only $1 billion of that matures in the next three years, giving the company plenty of time to get things in order.

Every dollar that goes into debt reduction increases the book value of the stock -- and rapidly. With a paydown of $550 million, the company could goose book value by nearly 40%. Shares trade hands at just three times free cash flow, and the company now pays out a nearly 5% yield. Those are three tremendous reasons I own the company myself.

Foolish bottom line
While not without its issues, SUPERVALU is cheap and solidly profitable. With a turnaround in progress, an industry veteran with a pedigree from the world's largest retailer at the helm, and a clear path to increase shareholder value through deleveraging, SUPERVALU is the cheapest, best stock I see.

But maybe SUPERVALU looks too debt-heavy for you? That's OK. The Motley Fool's Hidden Gems team has identified two small caps that are too small to fail. If you'd like free access to these two small caps "the government won't let go broke," just click here.

Jim Royal, Ph.D., owns shares of SUPERVALU. The Motley Fool owns shares of Wal-Mart and SUPERVALU. Motley Fool newsletter services have recommended buying shares of Wal-Mart. Motley Fool newsletter services have recommended creating a diagonal call position in Wal-Mart. Motley Fool newsletter services have recommended buying calls in 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.

Read/Post Comments (24) | Recommend This Article (124)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 18, 2011, at 6:15 PM, MyGoals627 wrote:

    Nice commentary and points that I agree with wholeheartedly. I'm in at a higher price, but the dividend has lessened that burden, and with the stock price down I'm adding to my position.

    I'm also considering adding some shares to my kids' portfolios. I can also see this company as a takeover play a few years down the road as they pay down debt and make themselves prettier for potential suitors.

  • Report this Comment On August 18, 2011, at 7:50 PM, showmethefacts wrote:

    Your analysis looks sound, but what's missing is a sense of whether this company delivers a good experience to its customers -- so they'll want to come back. Fro my personal experience, this chain will continue to struggle. We had Albertson's stores in Austin for many years, and they failed. Shopping there was a mediocre to bad experience every time. It was the closest store to my house, so I went -- but when I had time to go to an HEB or Randall's, I did. The Albertson's produce in particular seemed old and limited. The stores did not seem all that clean and pleasant. Displays were like 1980s, but in the 2000s... Prices were the same or higher than the two closest competitors (HEB and Randalls), but the experience was more akin to a generic discount grocery store. They just did not measure up to the competition. HEB eventually bought many of their locations, with dramatic turn-arounds in the stores I am familiar with. I wouldn't buy this stock without visiting some typical (not just showcase) stores and seeing if they are delivering a better shopping experience than what I witnessed.

  • Report this Comment On August 18, 2011, at 9:03 PM, tbenn210 wrote:

    i have shopped at Save-a-Lot and found the savings minimal to zip. Aldis is less expensive and a better shopping experience. For brand names, Kroger is just as inexpensive with the shopper's card. Save-a-Lot does have a few products that I haven't found elsewhere and Ido go there for those.

  • Report this Comment On August 18, 2011, at 10:18 PM, ayaghsizian wrote:

    I have been to Save-a Lot and the store looks very basic and economical. The prices are less than other stores. My Dad was surprised hot dog buns were 79c.

  • Report this Comment On August 19, 2011, at 1:05 AM, rhoop wrote:

    This stock's been on a downward trend since 2007 and after five years trails the S&P over 60% Even with the dividend you don't break even. It may be a good company but it's a bad stock. Much better yield plays out there.

  • Report this Comment On August 19, 2011, at 10:27 AM, WestBend1 wrote:

    How did you figure that this company will add to book value by paying down debt. From the Fool website, it shows that expectations for next year's profits are $267 million. So even if they paid down debt by $550 million, book value will only increase by $267 million. The rest of the reduction in debt will come from reducing their cash position.

    They are paying an interest rate on this debt of around 9.5%, so if they reduce debt by $550 million, it will save them around $52 million in interest expense, which amounts to $0.24 to $0.25 cents per share. That alone would increase EPS by 19%. By the way, I did not crack a filing. I am using the information on the Fool website. I figured their interest rate by dividing their interest expense by their average debt for the last four quarters. I also used the website for the total shares outstanding, so my information could be wrong.

    If their paying 9.5% on their debt, maybe the real sales pitch here should be buying their bonds.

  • Report this Comment On August 19, 2011, at 10:38 PM, xserver wrote:

    I think the poster above needs to educate himself on the differences between cash flow and earnings.

  • Report this Comment On August 22, 2011, at 11:31 AM, Tropazzz wrote:

    1) Dividend will be cut in 2012. CEO has put the writing on the wall for that one.

    2) No way they open 210 new stores. CEO already cut that to 160 in a recent interview.

    3) They only opened 3 new net stores last quarter. Good luck hitting that target!

    4) Agree with other poster. Google is a better stock.

  • Report this Comment On August 22, 2011, at 11:41 AM, catoismymotor wrote:


    I don't own it and have no plans to buy it in the next three months. But it is on my short list.

  • Report this Comment On August 22, 2011, at 11:43 AM, PeteysTired wrote:

    When a Walmart, Target and SVU grocery store are in the same area SVU price's are always higher. They simply can't compete.

    There only hope is to try to become a specialty grocier.

  • Report this Comment On August 26, 2011, at 11:42 AM, HappyDog777 wrote:

    Investing in grocery stores may not be a reasonably practical thing to do. Why? Unless you venture into grocery stores regularly, you may notice a lot fewer products on the shelves and those who stock the shelves (vendors) say there's no stock to put out because less and less is being delivered. So, either the stores are really hurting or the product suppliers and holding back deliveries in order to drive up pressure to increase the price because people will panic.

  • Report this Comment On August 26, 2011, at 12:39 PM, Weilster wrote:

    I have a new store in my neighborhood called Mariano's - a subsidiary of the Roundy chain from Wisconsin. It is run by Bob Mariano, former CEO of Dominick's before the Safeway takeover. We have a Jewel/Osco across the street. Their business has been cut in 1/2 or more by Mariano's. The Jewel shopping experience was mediocre at best and I haven't seen it get any better over the last year. Mariano's plans to open approximately 20 stores in the Chicago area (2 are open now with a 3rd on the way.) As far as I can see Jewel can't compete unless they create a better experinece for the shopper, improve their generic brands to meet those of Roundy's and bring their pricing into line - they are overall more expensive than Mariano's, Aldi, Walmart and Target while not providing any incentive to shop there. Financing and numbers aside it is feet in the door that will tell the tale. I'd be surprised if SVU will do what is necessary. Not something I'd stake my money on.

  • Report this Comment On August 26, 2011, at 12:48 PM, IlanBigfoot wrote:

    Here is Florida, our local Aldi is the cheapest (rats! a private co.). Sav-a-lot is the next best, cheaper than Target or Wal-mart. We don't have a Kroger, but we are crawling with the very expensive Publix.

  • Report this Comment On August 26, 2011, at 1:44 PM, birder1500 wrote:

    Doesn't seem like this is a pick for the faint of heart. Maybe in a couple of years it would be worth evaluating again.

  • Report this Comment On August 26, 2011, at 2:22 PM, PeakOilBill wrote:

    You won't make a lot of money on grocery stores. It is too competitive. Go for the Big Oils. Unless the European banks melt down, you will make more in oil than grocery stores. After peak oil hits in 5 to 10 years, you will make a killing. Check out their stock prices when the speculators drove up the price before the housing collapse hit. That WILL happen again. You can collect a 3+% dividend while you wait, if you buy the super majors.10,000 gallons of oil consumed every second can't go on for too much longer. That is 2&2/3 CUBIC MILES burned every year. Want to gamble? Buy EOG and wait for a buyout. Instant fat profit.

  • Report this Comment On August 26, 2011, at 2:49 PM, meatmann50 wrote:

    I retired from safeway after 35yrs...It's a cut-throat business,to competitive.I worked a couple years at Albertsons and they ARE terrible!!!There are so many other company's to buy with better growth and dividend potential,and I agree dividend WILL be cut.The safest grocer to buy is Safeway,and maybey Groger.As individual investors there are better opprotunities in the stock market than grocery stocks.

  • Report this Comment On August 26, 2011, at 4:43 PM, tedstips wrote:

    I live in San Antonio,and HEB ran Albertsons out a few years ago.SVu is selling for a mid 1980's price thus providing no returns to anyone except Rip Van Winkle.

    Except for a merger rumor,this could go the way of the Fla. growth grocery chain,Winn-Dixie.

    Another value trap.Call the number1-800- avoid grocers.

  • Report this Comment On August 27, 2011, at 1:02 AM, boger1 wrote:

    Nan above notes that Publix is expensive.

    It's also highly successful due to the incredibly pleasant shopping experience and excellent service. Truly a customer-first store. Refunds or exchanges without receipts. Freshest milk, produce and meats.

    Prices are not significantly higher than other stores on many items; perhaps 10% higher.

    Publix is like the Wegmans of the South. Without the fancy deli and specialty foods of course.

  • Report this Comment On August 29, 2011, at 1:32 PM, Truth2Power wrote:

    Had an Acme grocery store (chain bought by Albertson's) near my house growing up. Great produce! They managed to keep the great produce even after the SUPERVALU takeover, but cashier service suffered. Love Wegman's (or, at least, I did when I lived in central NY state), but with exposure to Costco (COST) and Whole Foods (WFMI), I'm not sure I have room for another stock in this sector...

  • Report this Comment On August 29, 2011, at 7:08 PM, franciswilson235 wrote:

    I have tried to comment on your subscription

    policy of automatic renewal with charge card.

    I tried to join one of your special offers but

    was unable to get any responce to my question

    about not wanting to have an automatic renewal

    at the end of my time period.

    I was also having trouble getting thur with

    email to make my feeling known.

  • Report this Comment On August 30, 2011, at 1:20 PM, dake105 wrote:


    If you are serious about your recomendations, here is your certificate. Report to the nearest insane asylum for admission.

    There are good stories, and then, there are good stocks.

  • Report this Comment On August 30, 2011, at 6:35 PM, burlybull1 wrote:

    Sounds like another SSW.

  • Report this Comment On August 30, 2011, at 11:38 PM, WineHouse wrote:

    Alas, I own Supervalu. Not much. I bought some Albertson's a long time ago, because it was a booming local supermarket in my area, a major rival to Publix (more presence than Winn Dixie). After Supervalu bought the chain I continued to have big hopes. But I watched -- too slowly -- while Supervalu's mismanagement drove it down the tubes. There are no Albertson's stores in my neighborhood any more, and the Winn Dixies are disappearing like flies -- today, the nearest Winn Dixie is more than 4 miles away and doomed I think, but we have Publix stores (mostly either new or renovated) at every mile point east-west and north-south. Publix is privately held, and that seems to result in far better management than the public-shares model. If someone wants to buy my few shares of Supervalu for anywhere near my original investment, give me a call!

  • Report this Comment On September 17, 2011, at 7:12 PM, WineGuyNJ wrote:

    You are barking up the wrong tree. I have watched the decline of SVU stores for years. I live in the ACME area. I regularly drove right by the Acme w/in a 1/2 mile of my house to go to better run and less expensive stores. this summer I went in a Shaws (not knowing it was a SVU chain) and left it very disappointed. (Again another nearby store better run and cheaper)

    I am a WB acolyte. He says buy management. Thye could not manage their way out of a paper bag. ( OOPS pun unintended)

    I will watch them and see what happens, and catch them for a short steep ride if the new CEO succeeds. Otherwise too risky.

    Another issue--ACME is still here because of a VERY LOYAL following of older folks who have lived all their lives in Delaware valley. You change the name as he has suggested and run a big risk of losing them too. Acme's market share has been shrinking quickly and all its stores are OLD and Tired. ( I think that means he will need a lot of cash to turn that one around)

    LABEL ME Mr. Skeptic on this one

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