SN Analysts' Roundtable: Part 2

SN Analysts' Roundtable: Part 2

Supervalu will continue to play defense unless it divests some of its retail properties, according to analysts at the 15th annual SN analysts' roundtable. I think Supervalu would like to see itself as a smaller company, Neil Currie, executive director at UBS. New York, said. Besides divesting individual stores, it would also like to sell all of Shaw's and Acme if possible moves that would certainly

Supervalu [4] will continue to play defense unless it divests some of its retail properties, according to analysts at the 15th annual SN analysts' roundtable.

“I think Supervalu would like to see itself as a smaller company,” Neil Currie, executive director at UBS. New York, said. Besides divesting individual stores, “it would also like to sell all of Shaw's and Acme if possible — moves that would certainly be transformational from a balance-sheet perspective.”

Gary Giblen, executive vice president of Quint Miller & Co., New York, offered a similar comment. “The history of the industry suggests Supervalu has to make some divestitures. Think of Safeway [5] 20 years ago — stores with high market shares going in the wrong direction, so it sold off half the markets it was operating in. The result was less to fix and more money to fix it with.”

Scott Mushkin, managing director at Jefferies & Co., New York, argued that Craig Herkert [6], president and chief executive officer of Minneapolis-based Supervalu, isn't there to break up the company but to fix it. “It appears he would have to fail for some dramatic asset changes to take place,” he said.

Supervalu still has some wiggle room in its covenants that will allow it to continue to pursue a defensive strategy for awhile, Mark Wiltamuth, executive director at Morgan Stanley, said. “It is playing a defensive strategy hoping the macro environment improves to help bail it out. The question is, how long will that take?”

For Andrew Wolf, managing director for BB&T Capital Markets, Richmond, Va., the lack of a long-term retail culture at Supervalu has made a true integration of its retail chains difficult, “[though] current management is doing a decent job executing at an integrated level, as evidenced by recent national big buy/big sell types of promotions,” he said.

“But it seems like too big a task to integrate this business now, so what Supervalu will try to do is muddle through without having the EBITDA of [its operating segments] go down a lot, and when an up-cycle comes, it can seek strategic divestitures.”

SN published the first part of the roundtable discussion in the Sept. 13 issue. In this second part of that discussion, the analysts talked about several chains. Their comments included the following:

  • • On A&P [7], Montvale, N.J.: “If the economy recovers and helps A&P out a little bit, maybe it can survive,” Susan Anderson, senior analyst with Citigroup, New York, said. If not, a financial restructuring might be a good idea, she added.

  • • On Winn-Dixie [8], Jacksonville, Fla.: “The goal [is] to fix it enough to sell it,” Anderson said.

The second portion of the roundtable follows.

SN: What's the outlook for Supervalu?

MARK WILTAMUTH: I think it is still going to be playing defense. It will still be holding back on price reductions because it can't afford to chase the price reductions of its peers, and it will be protecting margin and paying down debt. That's going to be its game.

In my view, Supervalu is kind of pursuing a kick-the-can-forward strategy — maintain the status quo, keep everyone happy in the debt markets and just hope that the macro wave comes along and saves it because it's got so much work to do on price reductions and remodeling that it's not easy to see it immediately turning around the dial on same-store sales, so it needs to protect cash flows for now.

GARY GIBLEN: Not to mention challenges on the wholesale side, which is still 22% of its business. Supervalu's independent customers are generally under pressure as never before for all the reasons we touched on before, and the company is seeing negative same-store sales and attrition of the number of wholesale customers.

NEIL CURRIE: I think Supervalu would like to see itself as a smaller company. I think it would like to sell more onesies and twosies types of stores, as it's done [with Albertsons] in Salt Lake City and [Shaw's in] Connecticut, and I think it would also like to sell all of Shaw's and Acme if possible. Those moves would certainly be transformational from a balance-sheet perspective and also from a stock market perspective, if it could do that — but that's a big if because there are few buyers out there right now.

ANDREW WOLF: Supervalu has got to be lighter. It has no financial flexibility right now.

WILTAMUTH: Shaw's has traded hands several times, and it has not worked for any of the acquirers. I don't know if that is going to bail it out.

SCOTT MUSHKIN: Shaw's would probably get split between Hannaford [9] and Stop & Shop [10].

WILTAMUTH: When you are comping a negative 7%, there are bound to be a lot of EBITDA negative stores you can start looking at jettisoning.

CURRIE: It's not just about that — it's about generating something like $800 million to $1 billion dollars in cash that could go to help improve the balance sheet so it could invest in stores it wants to build, but most importantly in Save-A-Lot because that is where it sees the future of the company. But I'm not sure the industry and economy is going to allow Supervalu to do that, so that's a big question mark.

WILTAMUTH: The beauty of Save-A-Lot is its licensing model. It produces a higher return because it involves someone else's capital, and you are selling wholesale groceries to those stores.

GIBLEN: The history of the industry suggests Supervalu has to make some major divestitures. Think of Safeway 20 years ago. You had stores with high market shares that were perpetually under-managed and going in the wrong direction in every single market, so it sold off half the markets it was operating in and got pretty good proceeds because of the high market shares. The result was less to fix and more money to fix it with. That, plus Steve Burd [11]'s brave new world of supermarket strategies, spurred the revitalization of Safeway.

WILTAMUTH: The challenge for Supervalu in this economy is, who is going to step up and pay a reasonable amount for under-performing grocery banners?

MUSHKIN: That's the biggest problem, and it can be really dilutive. What's becoming clear is, if this economy doesn't change, the path Supervalu is on is unsustainable.

You cannot continue to run a company with significantly negative comps quarter after quarter, so either you get a big economic bail-out or you're going to have to do something very dramatic, and I'm not sure Supervalu's current CEO, Craig Herkert, is ready to take such dramatic actions — he's there to fix it. It appears he would have to fail for some dramatic asset changes to take place.

In my opinion, many of Supervalu's assets would fit nicely with Kroger [12], like Chicago, Minneapolis, the Intermountain West and some of Southern California.

The sad thing about it is — and we've been big bears on Supervalu — operationally, this company is performing better than it has since before it acquired Albertsons.

WILTAMUTH: That's because it has been playing defense on margins — that's it in a nutshell. We've looked at Supervalu and its balance sheets and covenants, and it's actually got some wiggle room to let the defensive strategy play for a while. It doesn't have any big refinancings until 2013; it's got a $2 billion revolver to suck up any near-term debt maturities; and it's got a 20% cushion on cash flow before it starts breaking covenants.

The question is, do the earnings completely fall out of bed and change the cash flow number to the point where debt covenants are at risk?

CURRIE: When Supervalu is doing comps of negative 6% to 7%, the earnings can fall out of bed quite quickly, and even its own assumptions and guidance call for basically this being the low point.

WILTAMUTH: That's why I say it is playing a defensive strategy, hoping the macro environment improves to help bail it out. The question is, how long will that take?

SN: What about Supervalu's strategy to expand the Save-A-Lots format in different areas?

MUSHKIN: That's fine, but Save-A-Lot is tiny compared to what the company is.

WILTAMUTH: If it doesn't break out how big Save-A-Lot is, then that is telling you something. Supervalu is talking about doubling the size of Save-A-Lot, but it won't tell you how big it is today, which tells you it is probably pretty small.

MUSHKIN: It's small, and it should have been spun off to raise capital — and it wouldn't have been dilutive.

WILTAMUTH: Well, the challenge for Save-A-Lot is, you have to find entrepreneurs who are willing to put down $800,000 in an urban market and tie on the apron strings and then go run it.

GIBLEN: And it's tough for small business people to get financing these days.

MUSHKIN: So we saw Supervalu raise the number of Save-A-Lots it will open as corporate stores versus third parties.

GIBLEN: You can sum up the outlook for Supervalu by saying that either it's going to take aggressive divestiture steps, which would give it a shot at revitalizing the company as Safeway did two decades ago, or it is going to look a whole lot like Albertsons, which would be an unfortunate outcome. But that could be what we are looking at here — just steady erosion that finally ends in a death spiral where the company gets broken up for not a high price.

WOLF: When you go back and look at Supervalu's retail business, it's really the old American Stores that's a big part of it. And what was that? It was a roll-up that was never integrated. There was Jewel, but American Stores never used Jewel as a best-in-class platform because Sam Skaggs, who controlled American Stores, didn't believe in that — he believed in running each store group separately.

Then Albertsons bought American Stores, and it was poorly managed there, and now Supervalu owns all those assets, which are mainly the American Stores assets plus some Albertsons assets. You could argue that, between Skaggs and the Albertsons folks, Supervalu has the least retail acumen of the big three. That's why it had to bring in new management. But Supervalu was never a retailer as much as it was a wholesaler — though if we are talking Save-A-Lot, that was sort of Supervalu's crown jewel.

MUSHKIN: Supervalu used to talk about how good its retailing was, but it closed everything that was bad, like Atlanta and Denver, so there was a significant survivor's bias.

WOLF: Yes, most of its retailing experience came when it bought Richfood, so it's never been a retailer. There was Cub Food, which helped build market share and which was developed to enable the wholesale distribution business to get into the best buying brackets. So I agree with Neil — Supervalu most likely just doesn't have a strong enough retail culture to do what no one else has been able to do in terms of integrating this whole company, though it is trying. I think current management is doing a decent job executing at an integrated level, as evidenced by recent national big buy/big sell types of promotions.

But it seems like too big a task to integrate this business now, so I think what Supervalu will try to do is muddle through without having the EBITDA of these businesses go down a lot, and when an up-cycle comes, it can seek strategic divestitures.

WOLF: The real issue is, can Supervalu integrate this business like Kroger was able to do with Fred Meyer? Kroger is arguably the only highly successful integrator. But Supervalu's retail chains have proven difficult to integrate — and even if it turns out that it now has the management know-how, it would take a long time.

CURRIE: The problem is many, many years of under-investment.

WOLF: If any of these chains got sold to Kroger — Shaw's, Acme, Farm Fresh — Kroger could integrate all of them because it knows how to and it's been the best- in-class and it has a platform. A big issue with integrating assets is margin structure, and in some of these businesses the margins are too high, and when Kroger layers on its own margin structure, it realizes things will not work because Kroger isn't going to buy something that is going to be in the red from day one. But that aside, I think Kroger would be the natural acquirer. As much as Jewel and Acme have been under-invested in, they are still putting up some decent sales per square foot, and Kroger has said it isn't going to buy any companies that are in a death spiral. But the basis of the business is, does it have customer traffic, and most of the Supervalu businesses still have that going for them, so there is still some franchise value in most of Supervalu's individual chains.

CURRIE: I think it's all about whether there's a price at which Kroger will accept a fixer-upper because it has said it isn't interested in fixing up someone else's problems. There are very few supermarket assets out there to buy that don't have problems. And you said, quite rightly, you have to put them on Kroger's P&L structure, which could be quite risky this late in the cycle to do anything. It depends how much Kroger is willing to sacrifice that principal to justify getting a company at a super-low price. I'm sure it has looked at some deals and been approached by a lot of owners of these assets, and yet, it hasn't moved yet.

MUSHKIN: I think Kroger has been approached on Acme, and it might accept Acme if it could also get Jewel and Cub and the Intermountain West. I'm not sure it wants to take Acme by itself.

CURRIE: The problem with Jewel now is, it's got great market-share reach, but Aldi [13] also has a significant amount of stores in the Chicago market and Wal-Mart [14] just announced plans to open dozens of stores there, and there may be other entrants into that market as well, so Chicago is a risky market to be getting into right now.

MUSHKIN: Yes, it is, and Kroger is already there with about 25 Food 4 Less stores. But getting back to the original question of whether Supervalu is fixable — if given the time, we think Herkert and his team are implementing changes that could turn the company around. Whether they will be afforded the time to see those changes through is really unclear, but make no mistake — the company Herkert inherited had tremendous problems. Previous management did not act quickly enough to fix the Albertsons operations it purchased — it bought really good market shares but not premium assets.

CURRIE: Supervalu bought a company that had been dressed for sale, which had already bought some companies that had been dressed for sale like Shaw's, and then it proceeded to really focus on buying synergies and distribution synergies. In the process, it took this already under-invested asset when the rest of the industry was starting to get its act together and then let a couple of years go by when it didn't do anything to improve the business from a consumer perspective. Then a year ago Craig came in and said, we need to do something here. So we are talking about eight years after someone should have been thinking about doing something.

MUSHKIN: And Albertsons was just a very mismanaged company.

WILTAMUTH: Well, the thing you always wonder about is, how much cost-cutting is there under the hood? Could there be a wave of delivering numbers because Supervalu is squeezing out inefficiencies? It still doesn't solve the negative-7% comp problem, but it may extend the period of fighting.

CURRIE: The last time we saw a story like this was probably Winn-Dixie, where we were seeing negative 6% and 7% comps and where management decided to go after costs in order to address that, which ultimately didn't work.

A&P

SN: How are A&P's prospects looking after announcing plans to close 25 stores?

SUSAN ANDERSON: [The question is] what's Yucaipa going to do, and is it going to give A&P a lifeline?

I think the consensus is that A&P is going to get through the 2011 debt maturities, but after that we'll see what happens.

I think it's another economic story too. If the economy recovers and helps A&P out a little bit, maybe it can survive.

MUSHKIN: What are the best assets?

ANDERSON: Well, you have New York metro, right? People would probably be dying to get Food Emporium — that's one of the non-core assets it could potentially sell. In fact, it's probably the only one it could sell.

MUSHKIN: Food Emporium is a fixer-upper to the extreme. A lot of those stores haven't seen capital in 20 years.

SN: Is that what the issue is with Pathmark — a lack of investment?

ANDERSON: A lack of investment, and the prices are actually higher than at the A&P stores — and a price-impact format that has higher prices than its conventional format is a huge issue.

GIBLEN: And Pathmark has a lower-income clientele. Not a good combination.

MUSHKIN: The A&P stores have just been victims of under-investment, and to me, anyone who's going to do anything with A&P has got to fix that. It's a shame. If you go through the A&P/Food Emporium assets up to Westchester and Fairfield counties, the real estate is actually pretty darn good.

ANDERSON: I think there are some locations the company would want to get rid of, like the Washington, D.C., stores and other non-core locations. But it's hard to get real estate in the New York metropolitan area.

MUSHKIN: You're probably talking $4.5 million or $5 million a pop in the locations it hasn't touched. It's almost like starting from scratch.

SN: Can the Tenglemanns and Yucaipa survive this crisis?

ANDERSON: They both have enough money if they want to keep putting money into it, though I don't think Tenglemann wants to do that anymore — it's more of a pride thing for them, which is why they keep it operating rather than letting it to go into bankruptcy.

As for Yucaipa, I think it's really and truly interested in the assets, but it's going to take another six months for it to figure out if it's still a viable entity at this point.

CURRIE: The Pathmark deal managed to extend the life of some stores and create some synergies, but generally, with these kinds of smaller players, it's amazing how the assets stay in play. Over the next decade or so, I imagine there will be a real danger that those conventional assets will start to close down because there isn't a market for them.

ANDERSON: They have to close because there's too much over-saturation.

WOLF: What's amazing is that A&P has a 30% share in New York metro, and it's is the share leader, right?

ANDERSON: Yes, but I think it's lost 5% in the last five years or so. It's seen significantly declines every year. The only thing going for A&P at this point is its real estate.

Winn-Dixie

SN: What does Winn-Dixie's decision to close 30 stores indicate?

ANDERSON: I think Winn-Dixie has always been looking at the bottom tier of its stores. That's why it's only going to remodel 80% — because it didn't make sense to remodel the other 20%. So I think it probably decided, based partly on macro conditions, that it doesn't make sense to continue to operate those 30.

MUSHKIN: Winn-Dixie has a very difficult road to success. You've got low sales per square foot and low market shares — I think 11 of its 13 markets are below a 15% share, and its sales per square foot are among the lowest in the industry. The management team has done a great job of bumping along, but what's the point? If it decided to sell the company, Delhaize might be the most logical buyer.

ANDERSON: I think that's the goal — to fix it enough to sell it. I think Kroger was down there looking a couple of years ago, but obviously it wasn't interested because of the asset conditions. But fixing Winn-Dixie to the point where it could sell it is probably management's goal.

CURRIE: That's been the strategy for a lot of these companies for years now — to “shrink your way to greatness.”

MUSHKIN: Winn-Dixie has significant tax credits, mostly in the Carolinas, and because most interested buyers are going to want to utilize the tax losses, that seems to limit the potential buyers to Delhaize and Kroger, which already operate there.

I think Kroger is a long long-shot, honestly, because it's a unionized company and Winn-Dixie is not; and Winn-Dixie has low share and needs to be turned around, characteristics Kroger has said it really is not interested in. So I just don't see Kroger doing it.

Therefore, Delhaize, to me, is the only logical buyer. It's right up against Winn-Dixie in Jacksonville with its Harvey's stores. And Delhaize wants to expand, and I think it really messed up with its strategy in Florida when it took the Kash ’n Karry business and made it all Sweetbay, whereas if it had a two-pronged strategy down there, it would really have something, with Winn Dixie as its lower-end offering and Sweetbay as its higher-end format.

CURRIE: That may have been a strategy for better times.

MUSHKIN: That was a strategy for better times. And Delhaize probably wouldn't have to pay that much for Winn-Dixie and it will get the tax losses, so depending on what it pays, it could be almost a free option. But beyond that, I just don't see where Winn Dixie is going in this environment.

GIBLEN: One revealing thing when you see a chain closing a bunch of stores that are spread throughout its operating area — as Winn-Dixie said it would do with 30 stores or more — is that it is unsound strategically to close stores piecemeal. The proven road to a successful restructuring in supermarkets is to exit a smaller area and then use the capital to concentrate on other areas. Otherwise, all you're doing is hurting your economies of scale and going down the wrong way on the productivity cycle.

So Winn-Dixie should be exiting specific marketing areas or sub-market areas. But if it's just closing down 30 stores, then it's likely to do another 30 in another year, and it will just keep on shrinking and becoming less efficient and less of a salable economic entity. The endgame, as suggested by Scott, could well involve selling to Delhaize but in a weakened state and at a lower valuation than today's.