Stock Analysts Agree: Supervalu Is no 'Buy'

Supervalu (SVU) may be the least-loved large-cap stock on Wall Street: Not one of the 14 analysts who cover the supermarket company recommends that investors buy shares. Among the seven stocks in the Standard & Poor's 500-stock index without a buy rating, Supervalu is followed by the largest number of analysts, according to Bloomberg data.

Ordinarily diplomatic—and cautious when criticizing companies they cover—analysts are blunt about Supervalu, a 150,000-employee grocery chain that sells under various brands, including Albertsons on the West Coast, Acme in Philadelphia, Jewel in Chicago, and Shaws in New England.

"I don't think they're going to be able to recover from their current challenges," says Karen Short, an analyst at BMO Capital Markets, who rates the shares "market perform."

"Their base business is in a very poor position," says Jefferies & Co. analyst Scott Mushkin, who says shareholders would probably be better off if the company were broken up and sold to competitors. He has a "hold" rating on the shares.

In second-quarter results reported on Oct. 19, Supervalu's same-store sales fell 6.4 percent and total sales dropped 8.5 percent, to $8.66 billion, vs. year-earlier results. As consumers defected to other retailers, the chain's customer count was down 3.9 percent from a year ago, a decline that Janney Capital Markets analyst Jonathan Feeney called "awful." Feeney gives the shares a "neutral" rating.

Minuscule Price-to-Earnings Ratio

In the counterintuitive world of stock investing, unanimous negativity can attract buyers looking for a deal. "Overpessimism is what attracts us to the stock," says Thomas Villalta, lead portfolio manager of the Jones Villalta Opportunity Fund (JVOFX), a Supervalu shareholder. He says the stock is "significantly undervalued."

Supervalu shares are down 14 percent in 2010, compared to supermarket chains Kroger (KR) and Safeway (SWY), which are up 7.2 percent and 7.6 percent, respectively. For Supervalu, the price-to-earnings ratio, a common measure of valuation, is 6. For mass-market retail peers, the average p-e is 15, according to a Bloomberg data measure that includes Wal-Mart Stores (WMT), Kroger, Safeway, Whole Foods Market (WFMI), CVS Caremark (CVS), and Walgreen (WAG).

Craig Herkert, a former Wal-Mart executive, took over as Supervalu's chief executive officer in May 2009 and is trying to turn the company around by cutting costs, lowering prices, and paying down debt. "It may be too little, too late," says Ajay Jain, an analyst at Hapoalim Securities, who has a "neutral" rating on shares.

Analysts' list of concerns about Supervalu start with its debt load. At the end of the last quarter, the chain had $7.1 billion in total debt, most stemming from the acquisition of the Albertsons grocery chain in 2006, which more than doubled its sales while increasing its debt load sixfold.

Few worry that Supervalu could default on this debt soon. In fact, the company is paying debts down faster than it had previously indicated, including a $650 million reduction forecast by the company for this fiscal year, which ends in February.

Paying Debt Leaves Little Flexibility

"The debt is manageable for now," says Evan Mann, an analyst at credit research firm Gimme Credit.

The problem is that debt payments leave less money for other needs. "It doesn't give them a lot of business flexibility," Jefferies' Mushkin says.

And Supervalu has many urgent priorities. From marketing to technology, the company's systems are behind those of competitors in many areas, analysts say. "They're just so far behind, I don't know that there is any way to catch up," BMO's Short says. She adds that the chain also hasn't effectively responded to the latest retail trends, from discounters' new food offerings to the growth of specialty chains such as Trader Joe's. "They have not kept pace," she says.

Herkert, Supervalu's CEO, has acknowledged the problems and is trying to catch up. He has brought in a new management team, is centralizing such functions as marketing, and is changing the assortment of items on shelves to a more efficient mix. He is also positioning Supervalu as "America's neighborhood grocer" by adding more local merchandise to each store.

Analysts say many Supervalu stores need to be renovated, particularly those acquired in the Albertsons deal. "The Albertsons store fleet was kind of caught up in a time warp," Jain says. "You have to put a lot of capital in those stores, to wow customers [and] get them to come back," Short says.

Supervalu Can't Afford Pricing Wars

Kenneth Levy, Supervalu's vice-president of investor relations, says stores are being renovated and replaced at the correct pace. In fact, the condition of stores isn't the main reason for recent sales declines, he says: "Now, more than any other factor, customers are shopping based on price."

While Supervalu prices vary from one area of the country to another, analysts and executives agree that they are too high, compared to those of nearby competitors. In some geographic markets, Mushkin says, Supervalu's reputation for higher prices is so bad that it may need to price significantly below competitors in order to bring back customers—which would provoke rival supermarkets to respond. Given the chain's debt level, he says, "they just don't have the financial wherewithal to get in a pricing war."

Supervalu has started adjusting prices, although it's not trying to undercut discount stores such Wal-Mart. "We need to be fair on price," Levy says. "We don't need to be the low-cost provider." He notes that with its wide assortment and convenient locations, "there are clearly some advantages to being convenient to shop."

This is the dilemma that caused Don Wordell, portfolio manager of the RidgeWorth Mid-Cap Value Equity Fund, to sell his Supervalu shares in the late spring: Cutting prices makes it harder to pay back debt, but high prices are scaring away consumers. "I just don't see the light at the end of the tunnel," he says.

Wordell had been pinning some hopes on the possibility that Supervalu could raise cash by selling off stores, but most such sales have been small. On Oct. 29, Supervalu announced the sale of its 14-store Bristol Farms division. Sale terms were not disclosed. Supervalu has also been making acquisitions, including the purchase of a six-store pharmacy chain in Missouri and Illinois, announced on Oct. 18.

Could Save-a-Lot Save the Day?

As of July 20, Supervalu owned 1,161 supermarkets in the U.S., while also operating the 1,200-store Save-a-Lot discount chain and a food distribution business that serves 1,910 independent grocery stores.

The Save-a-Lot chain, which features small grocery stores selling only Save-a-Lot brand merchandise, is one source of investor hopes for Supervalu's future. "That's a real growth vehicle for the company," Levy says, noting plans to double the number of Save-a-Lot stores in the next five years.

There is also evidence that the sales slide at Supervalu's supermarkets could be stopping. The company projects same-store sales to improve from the first to second halves of its 2011 fiscal year. In the first five weeks of the current third quarter, same-store sales improved by one percentage point from the second quarter, senior vice-president of finance Sherry Smith told analysts on Oct. 19.

Whatever the reasons for hope, equity analysts see few catalysts to improve Supervalu's earnings in the near future, says Gimme Credit's Mann. Supervalu is "doing the right things but it takes time to change people's shopping behavior," he says, noting that any improvement could take two or three years.

Alan Lancz, president of investment firm Alan B. Lancz & Associates, has been buying Supervalu shares, betting they will rise along with other grocery chains when the economy improves and food inflation boosts the value of inventories. But he freely admits the company's serious problems. "With Supervalu, it's going to take a little patience," he says.

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