MINNEAPOLIS — Supervalu  last week said it would seek strategic alternatives including a potential sale of all or part of the company as part of sweeping plans to slash expenses and capital spending and increase price investments that one analyst termed a “shift to survival mode.”
The changes — which included the suspension of its dividend, the withdrawal of fiscal earnings guidance and a plan to replace its current credit facilities with more flexible loans backed by its real estate — will enable the retailer to accelerate price investments to rebuild sales momentum, Craig Herkert , chief executive officer of Supervalu, said. His announcement — a marked departure from his previous philosophy to protect profits while turning around the company — came as Supervalu revealed first-quarter financial results that were well below plan, including a 45% decrease in net income and comparable-store sales declines at conventional stores and its discount Save-A-Lot unit.
“We need to move faster to execute our strategy,” Herkert said in a memo to Supervalu employees last week. “The competitive environment we’re in demands that we do better.”
Although Herkert in a conference call with analysts last week said that the company was not considering bankruptcy, analysts said that was one possible scenario, as the company might find it difficult to sell assets or find a buyer, and is poorly positioned if its “fair pricing plus promotions” initiative sparks a competitive response or fails to catch on with shoppers.
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“Supervalu’s future is highly uncertain given the magnitude and speed of the deterioration [of fundamentals] in a seemingly unchanged environment,” said Karen Short, an analyst with BMO Capital Markets.
Other analysts were similarly skeptical. Fitch Ratings downgraded its credit ratings on Supervalu, citing deteriorating performance and increased risks in its revised strategy. John Heinbockel of Guggenheim Securities said he believed “prospects for success are not good,” noting that changing price perceptions is lengthy process. “It took Kroger five years to do so a decade ago, but the economy was stronger and the competitive environment less crowded,” Heinbockel said.
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Ajay Jain of Cantor Fitzgerald maintained a “buy” rating but dropped his price target and acknowledged a bearish sentiment around the stock would only increase as a result of its latest setback, which he called “a shift to survival mode.” While he acknowledged widespread skepticism that price investments would gain traction, Jain estimated that between expense cuts and the dividend suspension, Supervalu could have $400 million with which to offset its sales weakness.
“While we believed that the upbeat sales guidance provided just a few short months ago was insufficiently conservative, the sharp deterioration evident in Supervalu’s latest results is likely to result in renewed speculation regarding its ability to remain intact and solvent under its current structure,” Jain said in a research note. “We still maintain our view that the risk of bankruptcy is off the table, but the latest missteps by Supervalu could give fresh ammunition to what is already an extremely aggressive bear case with the stock.”
Scott Mushkin, an analyst for Jefferies, said he believed the announcement to invest in price might help attract strategic buyers looking to avoid a potential price war. “While we believe the company should have acted sooner, the combination of the asset-backed facilities along with the threat of aggressive price investments, at first blush, is perhaps shrewd,” Mushkin said. “Given the strategy, some competitors may take a harder look at the assets vs. what an extended price war would end up costing them.”
Herkert said that new cost savings — including $250 million in new expense reductions over the next two years in addition to previously announced $75 million in cost cuts — would be plowed directly into price reductions such as those already under way at its Jewel banner in Chicago. Herkert said the Jewel investments, which also include initiatives to improve produce presentations and emphasize “hyper-local” marketing, would be complete by Labor Day and are already showing promise.
“Our target is to have half of our network priced appropriately to the competition by March 2013,” Herkert said. “All banners will see sales-driving investments this year and will be executing the fair price plus promotion strategy by the end of fiscal 2014.”
Short of BMO Capital was particularly skeptical of pricing leading to a turnaround, saying she would expect competitors to react to protect their share and noting Supervalu’s relative weakness in markets outside of Jewel’s Chicago stronghold.
“Jewel is Supervalu’s strongest banner from a market share and positioning perspective, so even if the repositioning is successful at Jewel, we think it is risky to extrapolate success at Supervalu’s top banner to the company’s remaining (and weaker) banners,” she said.
The new lending agreements, backed by Supervalu’s real estate, will allow the company more flexibility to invest in price as it anticipates profits will come under further pressure in the near and medium term, Sherry Smith, Supervalu’s chief financial officer, said.
The new loans, which officials expect to close in August, include a $1.65 billion asset-backed line of credit and a standalone, $850 million loan secured by a portion of the company’s real estate portfolio. These financing arrangements will replace Supervalu’s existing credit facility, which included covenants that restricted the company’s ability to invest too aggressively, officials said.
“Let me state very clearly that what this enables us to do is to be more aggressive on our value transformation program,” Herkert said. “Our mandate from our board of directors and our desire is to move quickly to implement our fair pricing plus promotion strategy
across our entire traditional network.”
While a 3.7% decline in identical-store sales during the first quarter ended June 16 was not unexpected, the revelation that Supervalu’s discount Save-A-Lot stores suffered same-store sales declines of 3.4% was especially disappointing, analysts said. (Supervalu for the first time last week presented Save-A-Lot as a separate segment in its financial statements, a move it said provided investors with additional visibility to its discount operations and analysts felt signaled a new willingness to show it off for potential sale).
Herkert attributed Save-A-Lot’s struggles to an especially stressed customer base facing increased food inflation, as well to additional competition in the discount grocery arena.
“It’s a combination of the environment, the percentage of our customers who are relying on government assistance and the stress that puts on them, the general malaise of the economy and clearly competitive situations,” Herkert said when asked about Save-A-Lot’s struggles. He declined several times to elaborate on specific competitors affecting Save-A-Lot, but acknowledged there were “executional opportunities” at the banner “particularly as relates to being responsive as we need to be to consumer demands.”
Widely believed to be Supervalu’s most marketable asset, Save-A-Lot will be more difficult to sell now that it too is struggling, Heinbockel said in a research note. He estimated the company could sell Save-A-Lot for more than $2 billion, based on estimated EBITDA of $275 million. “Based on 1Q results, EBITDA appears to be running at a slightly lower annual run rate of $260 million and, with comps declining 3%, it may be difficult to get a double-digit EBITDA multiple,” he said. “Accordingly, the value may be lower than we once thought.”
Added Jain of Cantor Fitzgerald: “Our overall optimism on Save-A-Lot is tempered by the recent sales deterioration in what is widely viewed as Supervalu’s crown jewel.”
While analysts were largely supportive of the decision to seek strategic alternatives, the outlook was mixed.
“An outright sale of the business would be complicated by the weak trends within Supervalu’s core retail food segment, and its heavy debt load,” Fitch said in a research note. “However, the hard discount segment would be an attractive property to the right buyer, and the independent business is relatively stable, and could garner some interest.”
Supervalu said it would reduce fiscal 2013 capital expenditures from earlier estimates of $675 million to $450 to $500 million. Herkert said the cap-ex cuts would be “broad-based” including remodels and information technology but maintained that the asset base and historic spending has kept its store conditions in-line with competitors. Around 50% of its stores were remodeled in the last five years and a 85% in the last 10 years. “I’m reasonably comfortable we have an asset base that is appropriate for our customer,” he said.
Overall quarterly sales of $10.6 billion declined 4.7%. Save-A-Lot’s total sales increased slightly to $1.3 billion due mainly to a net increase of 53 stores from the same period a year ago. Net earnings of $41 million declined 44.6% from $74 million a year ago as gross margin as a percent of sales tailed down by 17 basis points. Herkert acknowledged the results “were well below plan.”
Supervalu engaged Goldman Sachs and Greenhill & Co. as financial advisors as it seeks strategic alternatives. Supervalu’s non-executive chairman, Wayne Sales, will oversee that process so management can remain focused on the new business plan.
The announcements last week came days after Supervalu said it had eliminated 39 marketing positions across the U.S. as part of continuing cost-reduction efforts. That move followed a corporate downsizing in February that eliminated approximately 800 positions at its corporate and regional offices, and the elimination in June of 2,300 to 2,500 jobs at its Southern California Albertsons division.
Supervalu last week said it had engaged Goldman Sachs and Greenhill & Co. to explore strategic alternatives, including the potential sale of all or parts of the company. The announcement followed several years of struggles for Supervalu, which transformed itself from a predominantly wholesale company to a retailer with its $19.9 billion purchase of Albertsons assets in 2006. Albertsons in 1998 had acquired its larger rival American Stores for $11.7 billion.
CEO: Craig Herkert
FY 2012 Sales: $35 billion
• Retail stores (approximately 1,110 traditional supermarkets including Jewel, Acme, Albertsons, Shaw’s/Star Market, Farm Fresh, Cub Foods, Shop n’ Save and Shoppers Food & Pharmacy.
• Save-A-Lot: Approximately 1,332 corporate and franchised hard discount stores.
• Independent: Serves approximately 2,700 independently operated stores through Independent Sales & Marketing and Wholesale Distribution segments.
• Warehouses: 15 warehouses comprising more than 20.5 million square feet.
Sources: company reports, 2012 Supervalu Fact Book
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