Tuesday, January 31, 2012

SuperValu LBO Update

Several quarters ago, SuperValu was discussed on this site as a potential opportunity for regular investors to participate in what looked like a leveraged-buyout type investment play. A few months after that article, shares were higher by about 25%. But today, shares of SuperValu can be had for 20% cheaper than their price when that article was published, even though the company is less risky now than it was then!

The biggest risk to this company is its large debt load (as is common in LBO situations). This is what the company's debt maturities looked at the time of the original article (note that the company generates about $1 billion per year in operating cash flow):

Fast forward a few quarters, and now added to the above chart are the debt maturities the company faces today (in red):

Through a combination of repayments (from SuperValu's ability to generate steady cash flow) and refinancing, the company looks a lot safer today. But even though the debt is lower, so is the market value of equity! With operating income steady at around $1 billion per year (adjusted for Goodwill and intangible write-downs that were created through acquisitions of a previous management), this leads to an EV/EBIT ratio of just 7.5.

With further debt repayments on the way (management expects to pay down $750 million more over the next two years from internally generated funds), that ratio should continue to shrink unless the market value of equity rises or EBIT falls. On future EBIT, the company's cost-cutting efforts are going well, which has allowed SuperValu to cut prices while maintaining margins. This should lead to increased competitiveness, holding the company's EBIT steady at the very least.

SuperValu's LBO-like characteristics are still present, but the company is safer and cheaper now than it was in the past. This opportunity may offer strong upside potential for those willing to take on a bit of downside risk.

* Note that the charts do not include SuperValu's capital lease obligations of approximately $1 billion

Disclosure: Author has a long position in shares of SVU


shlomi ardan said...

Hey saj,great post

The last annual report shows different numbers for debt maturities. Where did you get the updated debt maturity data?

Anonymous said...

I believe its more risky now. They have implemented new strategies again to stave off volume/sss declines and it hasn't worked yet. what do they have left? volumes are declining at 5-6% still. not long before they are finished at this rate.

Anonymous said...

The problem with the grocery industry is the wholesale prices of food are increasing. I am invested in a private restaurant chain and prices are up between 5% and 15% since June '11 for most of the food items we purchase. Grocers' margins are getting squeezed. And someone like SuperValu can't increase prices to offset because of the Walmart's and (now) Target's of the world. In fact, some of these grocers have been selling high frequency items like milk below cost to drive foot traffic. Given SuperValu's debt position, this is a bad problem to have. And one that is only going to get worse as world governments print more money and inflate their way out of their problems. Food costs will probably rise for years. I am personally staying away from the grocer space.

ed said...

Anonymous 2, do you have some theory as to why these price increases will not be passed on to consumers in the long run (or even the medium run)?

Anonymous said...

Debt is going down but EBITDA has been going down at the same time. The relevant question is: "which exponential function is going down faster?"

It would be far more expositive to post the same charts but use the debt and interest coverage ratios: net debt / EBITDA and EBITDA / interest expense.

Saj Karsan said...

Hi Shlomi,

I got the data from the latest 10-Q, and adjusted for subsequent events (i.e. further pay-downs) as per the latest conference call

Hi Anon2,

You are right that food inflation is a problem. SuperValu has actually had to use cash flow that would otherwise have been used to pay down debt to buy inventory forward (ahead of price increases). I don't take the dismal view of the future that you do though, as I expect higher prices to lead to farmer's growing more, which should moderate prices. Here's an example.

Hi Anon3,

You're right, looking at that would be useful, but it's hard to sort out what a normalized EBIT is amid all these writedowns and cost reductions. Last quarter was a good one from an EBIT perspective if you add back the one-time expenses, however, with improvement in the year-over-year ratio.

Anonymous said...

Thanks for bringing SVU to my attention... long forgotten stock.

Just getting my feet wet... but it seems absurd (given the excessive leverage) that they would be paying any dividend what-so-ever.

Great blog!

Anonymous said...

Good blog. In reference to an earlier post, the problem with wholesale food prices is not the farmer or lack or production capacity at the agricultural level, the problem is the link between the farm and the retail outlet. Control of the production and distribution of the food chain has been consolidated in half a dozen or so firms, who have been able to implement oligopoly pricing. Grocers can't fire their wholesalers or producers--there is no longer anywhere else to go. It will be hard to pass price wholesale increases to consumers in the gruesomely competitive retail grocery space.

Anonymous said...

"a bit of downside risk"? The downside here is zero... The performance of the company does not have to decline much from the current trend for the equity to get wiped out.

Anonymous said...

I think I hear Anon (Feb 29) laughing right now. Any updated commentary given recent developments?


Saj Karsan said...

Hi Anon,

Leverage is indeed dangerous! If the price cuts don't spur enough volume increase, this could be big trouble

Anonymous said...

Are you sticking with Supervalu after the recent bad news?

Saj Karsan said...

I am, but it's not for the feint of heart