On the evening of Wednesday, July 11, Supervalu (SVU, Financial) released earnings results and announced that they would be suspending their quarterly dividend. Shares dropped on Thursday from $5.30 to $2.75. The price had continued to decline by close of market Friday to $2.32, for a total discount of well over 50% from Wednesday's trading price. Looking on the surface, we see reported earnings of -$5.06, and a company heavily in debt. This might look like impending financial doom, but not so fast; a closer inspection reveals that things aren't nearly as bad as they might seem.
Who are they?
Supervalu is a chain of various grocery stores. Most of them are as the Sav-A-Lot brand, but they are also including other concepts.
They have a 70-year history of regular dividend payments, that was broken last Wednesday with their announcement to suspend future payments until further notice. They were doing okay as a company with the Sav-A-Lot concept until a massive acquisition in 2006. Results since have steadily suffered, but the price has taken an especially considerable dive in recent days.
The earnings release - What happened?
In the announcement they reported quarterly earnings of $0.19 per share on sales of $10.6 billion verses earnings of $0.35 per share on sales of $11.1 billion from the prior quarter. Along with suspending their quarterly dividend, they also announced additional actions to enhance shareholder value. These actions are:
1. Intensifying focus on expense reductions
- They intend to achieve an additional $250 million in administrative and operational expense reductions.
- They noted that they exceeded their expense reduction estimates for the past three years.
2. Enhancing financial flexibility
- The senior credit facility will get replaced with an asset-based lending facility and term loan secured by real estate. This will remove restrictive covenants on current debt.
- Reducing capital expenditures for 2013 to $450 to $500 million from $675 million. They still plan to do 40 store remodels and open 40 additional Save-A-Lot locations in 2013.
- Increasing debt reduction to a range of $450 to $500 million in fiscal year 2013 and to continue to pay down at least $400 million annually thereafter. They have less than $1 billion in aggregate debt coming due for fiscal years 2013 through 2015.
3. Acceleration of price investments
- This means they are taking some of the extra cash that they are freeing up and allocating it to price reductions in their stores.
4. Initiating a review of strategic alternatives
- Goldman Sachs and Greenhill & Co. will be working with the company chairman in conducting a review of strategic alternatives.
- They do not explain in the announcement or the conference call what it is that they have in mind with this, and give no assurance that it will result in any kind of transaction or a change to their business model.
The earnings release can be found here: http://www.supervaluinvestors.com/phoenix.zhtml?c=93272&p=irol-newsArticle&ID=1713981&highlight=
Some Background
The dividend announcement may be bad in the eyes of a dividend investor, something that tends to have them fleeing for the hills, but it's good news for a value investor with an understanding of risk and capital allocation. There isn't much to be excited about with the brands that they bought in 2006, but the Save-A-Lot concept is okay, and their prices are often even better than Walmart. The other grocery stores acquired are dragging the entire company down so it will be smart for them to dump those assets as soon as possible.
These are the results before the acquisition:
... and since the acquisition
Same store sales, revenues, and earnings have been decreasing for some time. Management is trying to pretend in their most recent conference call that it's because "their customers are stressed," but this is hard to believe when their competitors under similar circumstances are doing suspiciously fine. For example, Family Dollar makes a similar claim that much of their business is coming from customers on government benefits, but their same store sales are on the up and EPS gains are in the double digits.
Inconsistencies like this, along with the extra pay they made for themselves thanks to this acquisition, that has subsequently driven their investors into poverty, do not win them any bonus points for managerial integrity. We best not sugarcoat this. In fact, shame on them. They probably deserve to get continually pelted with distrustful questions from analysts in conference calls for the rest of their working careers. If incapable of handling the extra managerial complexity, they should pay investors back the extra money they paid themselves in the process of driving this company into its current state of desperation. In other words, although the value potential here is extremely strong, this is unlikely to be a good long-term hold if the integrity of management is under question.
Good trustworthy management is nice to have in an investment, but it's not a requirement. One must be careful not to fool oneself in either a positive or negative direction, but seek to make the most realistic assessment possible. For this situation, if their bad management is unjustifiably scaring other investors away, this is a good thing. That aside, executive compensation has largely been reducing as results have deteriorated, so they are not completely devious, but they do not win high managerial scores.
Reported vs. real financial situation
Their operational situation is not nearly as bad as it seems, but that is not to imply that things are good. Their reported results for the past couple of years include large impairments to goodwill on the balance sheet. It looks to me like this has more to do with reducing their income down to save on taxes and free up more money for debt reduction. As of now, their goodwill has been mostly tapped as an impairment resource.
Year Reported EPS
2012 -4.91
2011 -7.12
2010 1.85
2009 -13.53
2008 2.76
2007 2.32
2006 1.46
2005 2.71
2004 2.01
2003 1.86
The losses from 2012, 2011 and 2009 are the years of non-cash charges against goodwill. If we adjust those years for what EPS would have been without the charges, and average in from other years what the tax expense would have been, it looks like:
Year Adjusted EPS
2012 1.18
2011 1.01
2010 1.85
2009 2.18
2008 2.76
2007 2.32
2006 1.46
2005 2.71
2004 2.01
2003 1.86
Although adjusting for non-cash asset impairments, this shows the clear downtrend to earnings for Supervalu since the acquisition. If we were to look at adjusted earnings for the past four quarters to not include impairments, they would currently be at at $1 per share for the last four quarters. However, their cash flow situation is far friendlier than the income statement implies.
Debt situation also not as bad as it seems
Bankruptcy is always some kind of possibility for a company with debt, but this is not an immediate risk for Supervalu. Despite financial results deteriorating, they have been paying this debt down very heavily. They also intend to continue paying it down in the future, and have even more flexibility to do so now that they are suspending dividend payments. If you ask me, they should have suspended it years ago in order to pay the debt down even further. They could have an extra $600 million paid off from dividend distributions since 2008, but they have still managed to pay off quite a bit anyway. Either way, they have more financial flexibility now without dividend distributions. This is a good thing.
Long Term Debt, Billions of $
2012 5.87
2011 6.35
2010 7.02
2009 7.97
2008 8.50
2007 9.19
2006 1.41
2005 1.58
2004 1.63
2003 2.02
The value proposition
We see from the earlier analysis that their real EPS, although decreasing over the past couple of years, is currently at $1 per share. This puts their PE ratio at about 2.5. Let me say this again: their PE is 2.5. A PE this low is appropriate for circumstances of impending doom, but the sky is not (yet) falling on them to justify such a low price. Their current market cap is at $530 million, and they have paid out more than this amount in dividends since 2008.
Another way to look at is that they have over a billion in cash flow each year for the past five years, around half of that left over after capital expenditures. This puts one year of cash flow after capex as being close to equaling the entire market cap. The dividend money that was previously being distributed to shareholders isn't "gone," but is being allocated to other purposes.
We can see from the acquisition what executives are willing to do to make an extra buck, and currently all of their stock options are worthless. Investors have been ravaged so badly that now it looks oddly like interests are aligned.
They are indeed breaking a long, 70-year dividend history, but it makes sense to kill the dividend now to improve financial situation, especially considering how their stock options would be motivating them to make such a move. The dividend juice available isn't enough to boost the stock to a meaningful level, but reinvesting, at the returns that they get from checking the non-impairment years, could make it more worthwhile. Keep in mind with the following charts that the negative years are from non-cash impairments of goodwill. They were not losses in economic terms.
Year Return on Equity %
2012 -4,952.4
2011 -112.7
2010 13.6
2009 -110.6
2008 10.0
2007 8.5
2006 7.9
2005 15.4
2004 12.7
2003 12.8
Year Return on Assets %
2012 -8.6
2011 -11.0
2010 2.4
2009 -16.2
2008 2.8
2007 2.1
2006 3.4
2005 6.1
2004 4.5
2003 4.4
Conclusion
They are not an ideal company to own over the long haul, but the current price looks like a market prediction of impending doom and, considering the information discussed, does not represent an accurate reflection of their circumstances. They fully own 40% of their store locations. This is a considerable asset that has been getting left financially untouched. They are now using this to refinance their existing (and steadily diminishing) debt, and this should soon come with a better deal than what they already have. Maybe in the strategic review they will find a buyer for the other poor performing stores and bring a cash infusion, or maybe someone will buy the entire company to turn around their sloppy management practices. There are a lot of cards in their favor, and the current price drop looks like a severe reaction over what appears to have been a relatively minor development.
Disclosure
This is not an investment recommendation but an analytical investigation into a company. Do not be silly enough to take anyone's perspective as infallible, certainly not mine, but make sure to do your own independent research and verification.
I own shares in Supervalu.
Who are they?
Supervalu is a chain of various grocery stores. Most of them are as the Sav-A-Lot brand, but they are also including other concepts.
They have a 70-year history of regular dividend payments, that was broken last Wednesday with their announcement to suspend future payments until further notice. They were doing okay as a company with the Sav-A-Lot concept until a massive acquisition in 2006. Results since have steadily suffered, but the price has taken an especially considerable dive in recent days.
The earnings release - What happened?
In the announcement they reported quarterly earnings of $0.19 per share on sales of $10.6 billion verses earnings of $0.35 per share on sales of $11.1 billion from the prior quarter. Along with suspending their quarterly dividend, they also announced additional actions to enhance shareholder value. These actions are:
1. Intensifying focus on expense reductions
- They intend to achieve an additional $250 million in administrative and operational expense reductions.
- They noted that they exceeded their expense reduction estimates for the past three years.
2. Enhancing financial flexibility
- The senior credit facility will get replaced with an asset-based lending facility and term loan secured by real estate. This will remove restrictive covenants on current debt.
- Reducing capital expenditures for 2013 to $450 to $500 million from $675 million. They still plan to do 40 store remodels and open 40 additional Save-A-Lot locations in 2013.
- Increasing debt reduction to a range of $450 to $500 million in fiscal year 2013 and to continue to pay down at least $400 million annually thereafter. They have less than $1 billion in aggregate debt coming due for fiscal years 2013 through 2015.
3. Acceleration of price investments
- This means they are taking some of the extra cash that they are freeing up and allocating it to price reductions in their stores.
4. Initiating a review of strategic alternatives
- Goldman Sachs and Greenhill & Co. will be working with the company chairman in conducting a review of strategic alternatives.
- They do not explain in the announcement or the conference call what it is that they have in mind with this, and give no assurance that it will result in any kind of transaction or a change to their business model.
The earnings release can be found here: http://www.supervaluinvestors.com/phoenix.zhtml?c=93272&p=irol-newsArticle&ID=1713981&highlight=
Some Background
The dividend announcement may be bad in the eyes of a dividend investor, something that tends to have them fleeing for the hills, but it's good news for a value investor with an understanding of risk and capital allocation. There isn't much to be excited about with the brands that they bought in 2006, but the Save-A-Lot concept is okay, and their prices are often even better than Walmart. The other grocery stores acquired are dragging the entire company down so it will be smart for them to dump those assets as soon as possible.
These are the results before the acquisition:
... and since the acquisition
Same store sales, revenues, and earnings have been decreasing for some time. Management is trying to pretend in their most recent conference call that it's because "their customers are stressed," but this is hard to believe when their competitors under similar circumstances are doing suspiciously fine. For example, Family Dollar makes a similar claim that much of their business is coming from customers on government benefits, but their same store sales are on the up and EPS gains are in the double digits.
Inconsistencies like this, along with the extra pay they made for themselves thanks to this acquisition, that has subsequently driven their investors into poverty, do not win them any bonus points for managerial integrity. We best not sugarcoat this. In fact, shame on them. They probably deserve to get continually pelted with distrustful questions from analysts in conference calls for the rest of their working careers. If incapable of handling the extra managerial complexity, they should pay investors back the extra money they paid themselves in the process of driving this company into its current state of desperation. In other words, although the value potential here is extremely strong, this is unlikely to be a good long-term hold if the integrity of management is under question.
Good trustworthy management is nice to have in an investment, but it's not a requirement. One must be careful not to fool oneself in either a positive or negative direction, but seek to make the most realistic assessment possible. For this situation, if their bad management is unjustifiably scaring other investors away, this is a good thing. That aside, executive compensation has largely been reducing as results have deteriorated, so they are not completely devious, but they do not win high managerial scores.
Reported vs. real financial situation
Their operational situation is not nearly as bad as it seems, but that is not to imply that things are good. Their reported results for the past couple of years include large impairments to goodwill on the balance sheet. It looks to me like this has more to do with reducing their income down to save on taxes and free up more money for debt reduction. As of now, their goodwill has been mostly tapped as an impairment resource.
Year Reported EPS
2012 -4.91
2011 -7.12
2010 1.85
2009 -13.53
2008 2.76
2007 2.32
2006 1.46
2005 2.71
2004 2.01
2003 1.86
The losses from 2012, 2011 and 2009 are the years of non-cash charges against goodwill. If we adjust those years for what EPS would have been without the charges, and average in from other years what the tax expense would have been, it looks like:
Year Adjusted EPS
2012 1.18
2011 1.01
2010 1.85
2009 2.18
2008 2.76
2007 2.32
2006 1.46
2005 2.71
2004 2.01
2003 1.86
Although adjusting for non-cash asset impairments, this shows the clear downtrend to earnings for Supervalu since the acquisition. If we were to look at adjusted earnings for the past four quarters to not include impairments, they would currently be at at $1 per share for the last four quarters. However, their cash flow situation is far friendlier than the income statement implies.
Debt situation also not as bad as it seems
Bankruptcy is always some kind of possibility for a company with debt, but this is not an immediate risk for Supervalu. Despite financial results deteriorating, they have been paying this debt down very heavily. They also intend to continue paying it down in the future, and have even more flexibility to do so now that they are suspending dividend payments. If you ask me, they should have suspended it years ago in order to pay the debt down even further. They could have an extra $600 million paid off from dividend distributions since 2008, but they have still managed to pay off quite a bit anyway. Either way, they have more financial flexibility now without dividend distributions. This is a good thing.
Long Term Debt, Billions of $
2012 5.87
2011 6.35
2010 7.02
2009 7.97
2008 8.50
2007 9.19
2006 1.41
2005 1.58
2004 1.63
2003 2.02
The value proposition
We see from the earlier analysis that their real EPS, although decreasing over the past couple of years, is currently at $1 per share. This puts their PE ratio at about 2.5. Let me say this again: their PE is 2.5. A PE this low is appropriate for circumstances of impending doom, but the sky is not (yet) falling on them to justify such a low price. Their current market cap is at $530 million, and they have paid out more than this amount in dividends since 2008.
Another way to look at is that they have over a billion in cash flow each year for the past five years, around half of that left over after capital expenditures. This puts one year of cash flow after capex as being close to equaling the entire market cap. The dividend money that was previously being distributed to shareholders isn't "gone," but is being allocated to other purposes.
We can see from the acquisition what executives are willing to do to make an extra buck, and currently all of their stock options are worthless. Investors have been ravaged so badly that now it looks oddly like interests are aligned.
They are indeed breaking a long, 70-year dividend history, but it makes sense to kill the dividend now to improve financial situation, especially considering how their stock options would be motivating them to make such a move. The dividend juice available isn't enough to boost the stock to a meaningful level, but reinvesting, at the returns that they get from checking the non-impairment years, could make it more worthwhile. Keep in mind with the following charts that the negative years are from non-cash impairments of goodwill. They were not losses in economic terms.
Year Return on Equity %
2012 -4,952.4
2011 -112.7
2010 13.6
2009 -110.6
2008 10.0
2007 8.5
2006 7.9
2005 15.4
2004 12.7
2003 12.8
Year Return on Assets %
2012 -8.6
2011 -11.0
2010 2.4
2009 -16.2
2008 2.8
2007 2.1
2006 3.4
2005 6.1
2004 4.5
2003 4.4
Conclusion
They are not an ideal company to own over the long haul, but the current price looks like a market prediction of impending doom and, considering the information discussed, does not represent an accurate reflection of their circumstances. They fully own 40% of their store locations. This is a considerable asset that has been getting left financially untouched. They are now using this to refinance their existing (and steadily diminishing) debt, and this should soon come with a better deal than what they already have. Maybe in the strategic review they will find a buyer for the other poor performing stores and bring a cash infusion, or maybe someone will buy the entire company to turn around their sloppy management practices. There are a lot of cards in their favor, and the current price drop looks like a severe reaction over what appears to have been a relatively minor development.
Disclosure
This is not an investment recommendation but an analytical investigation into a company. Do not be silly enough to take anyone's perspective as infallible, certainly not mine, but make sure to do your own independent research and verification.
I own shares in Supervalu.
