Supervalu Slowdown May Speed Asset Sales

Supervalu last week warned investors that its first-quarter earnings would be significantly below previous expectations, which some analysts suggested could accelerate an effort to sell off some operations. The asset base needs repositioning and capital, and the environment remains challenging, Karen Short, an analyst with Friedman, Billings, Ramsey & Co., New York, said in a research

MINNEAPOLIS — Supervalu here last week warned investors that its first-quarter earnings would be significantly below previous expectations, which some analysts suggested could accelerate an effort to sell off some operations.

“The asset base needs repositioning and capital, and the environment remains challenging,” Karen Short, an analyst with Friedman, Billings, Ramsey & Co., New York, said in a research note. “In our view, the company should sell assets to de-lever.”

She estimated that Supervalu could reap about $3 billion from the sale of its West Coast operations — 427 Albertsons and Bristol Farms stores — plus its Save-A-Lot limited-assortment chain.

Scott Mushkin, an analyst with Jefferies & Co., New York, agreed that an effort to sell off some assets was “highly likely” as the company's new chief executive officer, Craig Herkert, seeks to reduce the company's large debt burden and focus on the assets that are generating the best return on investment.

“Craig's got a huge, huge, huge challenge in front of him,” Mushkin told SN last week, citing ongoing struggles in various regions around the country.

In a prepared statement last week, Herkert said he was “engaged in a full review of [Supervalu's] operations and support functions.”

Supervalu said it expects net income for the first quarter, which ended June 20, will be “substantially below” analysts' estimates and said same-store sales would be down about 3% for the period.

“Consumers have become more value-focused and cautious in their spending, which has pressured sales and margins greater than anticipated,” Herkert said.

The company said it planned to update its guidance for the year when it issues a full report on first-quarter results on July 28.

In April, during a conference call discussing financial results for the last fiscal year, Supervalu revised previous projections for the current fiscal year downward to a range of $2.50 to $2.65 per share on about $43 billion in sales. Identical-store sales were projected to be plus or minus 1% for the full year, and distribution sales were projected to be down about 5%, reflecting the shift of Target Corp. to more self-distribution.

Gary Giblen, an analyst at Axiom Capital, New York, said it was “kind of a lame excuse” for Supervalu to say consumers were getting more cautious, “when everyone else in the industry is saying that while things may not be getting better, they are not getting worse.” Kroger, for example, a day earlier described a more stabilized spending environment.

Analysts pointed out that although it might make sense for Supervalu to sell off some of its businesses to repay debt and divert capital to areas that need it, the company might have difficulty finding buyers in the current economic climate. In addition, the company has to weigh the one-time proceeds it might gain from divestitures against the ongoing cash flow it would be forfeiting without them in its portfolio.

Mushkin of Jefferies & Co. suggested that one option might be for the company to spin off a stake in its Save-A-Lot banner as an initial public offering. That would allow Supervalu to continue to recognize income from the division while generating some capital in the short term.

“Save-A-Lot is interesting, because they can IPO 20% of it, let's say, and unlock some of the value,” he said. “They can pay down some debt, but not give up the EBITDA.”

He pointed out that given the strong financial results recently posted by other discount chains, such as Family Dollar and Dollar General, the market could be interested in shares of Save-A-Lot as a separate entity. The banner includes about 317 company-owned stores and another 863 that are licensed.

Mushkin also said Supervalu could seek to sell the Shaw's banner in New England and some of the legacy Supervalu chains that lack No. 1 or No. 2 market share. Shaw's could be worth at least $1 billion, possibly much more, he suggested, although, again, the challenge would be in finding an interested buyer.

In addition, he said the distribution operations, which account for about 25% of the company's revenues, could be part of a divestiture.

Short of FBR noted that because the distribution business requires less capital investment, it may be more attractive to private equity than some of Supervalu's retail assets.

Although Supervalu's distribution operations serving independents are intertwined with its own self-distribution operations serving Albertsons and other banners, Mushkin said it may be easier to untangle them than former CEO Jeff Noddle previously had suggested.

“We do know there are some interested parties in some of the assets,” he said. “Maybe not all of it, but parts of it are definitely saleable.”

He suggested that Supervalu could consider selling certain warehouses to other wholesalers — C&S Wholesale Grocers, for example — and then contracting for C&S to supply the Supervalu-owned stores in that region.

“There's a lot that can be done to monetize those assets,” he said.

As the new CEO, Herkert should be looking at all aspects of the business and evaluating his options, analysts said.

“He's got a balance sheet that's not optimal, and I think he's going to want some breathing room from covenants,” Mushkin explained.

In April, Supervalu said the company's total debt at the end of fiscal '09 was $8.5 billion, down more than $1 billion since the acquisition of Albertsons. Its debt-to-total capital ratio was 77%.

Pamela Knous, executive vice president and chief financial officer, told analysts that the company was “in full compliance” with its debt covenants.

Roberts Summers, an analyst with Pali Capital, New York, said it is difficult to put a value on Supervalu's assets because the company does not break out EBITDA for individual divisions. He suggested the company's operations in the Pacific Northwest might be a candidate for divestiture.

“They might be generating significant proceeds, but the outlook over time isn't that positive,” he said. “Every market over time evolves to where you have a No. 1 and a No. 2, and they are distant No. 3 in those markets.”

He agreed that now might be a good time to monetize Save-A-Lot, and also suggested that some Acme stores could be divested.

Although Summers said he doesn't expect Herkert to make any announcements about asset sales on July 28, if he does indicate an openness to do so, that would signal a shift from Noddle's position, and investors would give Herkert “the benefit of the doubt from the start.”