Thursday, January 10, 2013

SVU Deal Good for Present: Future Outlook TBD.

Supervalu today announced the end product of the long-running review of strategic alternatives for the company.  SVU will sell 877 retail stores for $100 million cash and the assumption of $3.2 billion in associated debt to an affiliate of Cerberus Capital Management.  The store banners include Albertsons, Jewel-Osco, Shaw's, Star Market and Osco/Sav-On in-store pharmacies.  The acquired Albertsons stores are heavily concentrated in Southern California, along with another cluster in the Mountain and Pacific Northwest states.  This acquisition was a disaster from the get-go, and it was never going to get better under Supervalu's ownership.  Ironically, Cerberus will now add  some 400 Albertsons stores from Supervalu to the 162 that it owns from a prior transaction: Albertsons is born again!

The entry into Chicago through the acquisition of Jewel-Osco also was never worth the price paid, and competition from Dominick's, along with Supervalu's weakened position, meant continuing investment in margin without a real return.  So, some analysts might argue that the price paid by Cerberus on a pro-forma per store basis doesn't look rich, but Supervalu's equity value would be burdened interminably by owning these assets.  Getting rid of them, along with some $1.2 billion in liabilities of a multi-employer pension plan, is a good deal for long-suffering shareholders.

The second part of the deal takes the form of a tender offer by Cerberus and a very interesting set of four astute real estate partners, including KIMCO and Schottenstein Real Estate Group. The consortium, called Symphony Investors, will tender for up to 30% of the outstanding shares of SVU at a price of $4.00 per share, a significant premium to its thirty-day average trading value.  This also is a valuable option for shareholders who desire liquidity after the unfulfilled promises of recent years.  The floor for Symphony's acquisition through the tender is 19.9% of the shares (a tax issue), and Supervalu would make up the difference by issuing new shares so that Symphony's post-tender holdings amount to 30% in the ongoing company.

This too is good for continuing shareholders, as it aligns the interests of Cerberus/Symphony and Supervalu management.  Five members of the existing board will resign, and five directors will stay on.  Cerberus/Symphony will immediately add two directors, one of whom is Robert Miller, President and CEO of Albertsons LLC who will take over as non-executive Chairman of the Board.  Four more directors will expand the board to eleven members.  Sam Duncan, a very experienced retail operator, will take over as President and CEO of Supervalu and join the board, along with another Cerberus nominee.  Finally, a search is on for two independent directors. From the executive management and governance standpoints, these changes bring much more industry operating expertise, real estate expertise, and financial acumen to the board.  This too is a good thing.

When the review of strategic alternatives for Supervalu began quite a while back, the avowed goals were the following:

  1. Improve the current operating profile of the company;
  2. Position the company for future growth;
  3. Create shareholder value.
Progress on the first objective has been de minimus , for all the rhetoric.  Excising the 877 bleeding stores, along with the new management and directors, should allow more rapid, meaningful progress to made on improving the operations.  The company's position, with lower ongoing capital expenditures,  better debt and working capital structures, and a more focused retail, is better.  The creation of shareholder value in the future is the big question.  The answer isn't clear, yet, but the odds are better now than before.  

Current CEO Wayne Sales said it best, in response to a question about whether the company had been significantly deleveraged.  To paraphrase, he said, "I wouldn't say that it has been deleveraged; it has been derisked."  That is a fair and accurate statement.  

What remains of Supervalu retail?  Their independent retailers, which they unfortunately referred to as their "legacy business," comprise 1,950 stores, which are 47% of the remaining $17 billion in retail sales.  The Sav-A-Lot business has 1,300 stores, representing 25% of retail sales.  The remaining retail stores(28% of sales) are what used to be the core of the original retail business, banners like Cub Foods (39 stores), Farm Fresh (42 stores), Shop 'N Save (103 stores) and Hornbacher's (191 stores).  Cub, like some of these others, is a mixture of corporate and licensee stores. 
What doesn't compute going forward is the size and composition of the distribution centers that support the approximately 2,000 remaining retail stores.  According to the Supervalu 2012 Fact Book, the retail support operations comprise 20.6 million square feet.  Something has to give here, and some of the distribution centers assets may need to be sold, but the good news is that there some of the sharpest retail real estate operators now have a stake in the company and will be represented on its board.  

The biggest item, in my mind, is the much-ballyhooed expansion of Save-A-Lot.  Save-A-Lot, unlike traditional food retail, is not an operations play; it is a real estate play.  Finding the small store in the right second or third tier center with the right demographics makes the format's economics work. We may have passed the bottom in the commercial real estate cycle, but there should be opportunities to roll the format is the real estate can be assembled.  The logistics and support, on the other hand, require very small distribution centers, nothing like the mammoth Supervalu facility in Hopkins, MN, for example. 

With a few thousand items, mostly private label, in a limited assortment store, the operations are relatively simple.  The real estate is the key.  It may now be that Supervalu is finally positioned to execute on the roll-out of Save-A-Lot.  The answer to this question won't be evident in a quarter or two, and looking at the most recent quarter, there are still problems in executing at Save-A-Lot.  

Quarter Three Results

Sales were $7.9 billion in the fiscal third quarter, and GAAP EPS was $0.08 per share. Netting out one-time gains and losses of $0.05, non-GAAP operating EPS was $0.03, significantly below a poorly estimated consensus of $0.07. Identical store-sales ("IDs") declined by 4.5%, which was an acceleration from -4.3% in the prior quarter.  Customer counts were lackluster, items in the basket declined, and average retails per item were also down.  Overall, the consolidated gross margin declined 70 basis points: not a good thing. Wholesale sales were flat.  

General and administrative expenses were a whopping 19.5% of sales compared to 19.3% in the prior year period.   Operating income margin declined from 2.4% in the prior year period to 1.8% in the current third fiscal quarter.  Public shareholders aren't going to see value added from this kind of margin on declining identical store sales. 

Worst of all, results at Save-A-Lot deteriorated as the operating margin in this format declined dramatically from 6.1% in the prior year period to 3.9% in the current fiscal third quarter.  Corporate operated stores did worse than licensee stores. (A small item in one of the press releases notes that founder Bill Moran's company is an investor in the restructured Supervalu---that's a good thing among this dismal news).  Save-A-Lot has large concentrations of stores in Ohio (remember that Schottenstein Realty Group's home base is Columbus, OH) and Florida.  Florida's higher than national average unemployment rate put pressure on food retailers in that state, the CFO said.  

The assortment in Save-A-Lot has become stale.  Comments were made about introducing 200 or so new items into the assortment which were more relevant to the more strapped shoppers.  Hopefully, with new management and an active board, this process too will move much faster.  

The company, even from when I followed it long ago as a retail analyst, had major IT problems. A relatively new executive has taken over this portfolio.  If she is able to cut through the mangrove swamp of systems and bring the staff up to the industry standard, then better buying, better working capital utilization and better, fresher assortments for the independent customers will become achievable.  Can this be done?  Maybe, but we won't know in two or three quarters.  

The company has suspended guidance, but it will need to reinstate it if it wishes to get fresh interest in the stock.  Their whole investor relations effort needs to be turned upside down.  I followed Kroger through its hair-raising  leveraged recapitalization, where it survived triple couponing, a recession, Wal-Mart and Sam's Club,declining food price inflation and Albertsons.  It can be done, and hopefully Supervalu has started down the road.  

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