This Wal-Mart Defector May Create the Turnaround Story of the Year

When the Lakers were looking for someone to lead them to a national championship, they turned to Hall-of-Fame coach Phil Jackson. He had a proven record: Six NBA championships during the 1990s.

Hiring Jackson paid off. Since hiring this proven winner in 1999, the Lakers have won four NBA championships.

The same concept works in business. If a board wants the company to succeed, it should hire executives with a proven track record. That’s what Supervalu (NYSE: SVU) did when it hired former Wal-Mart (NYSE: WMT) executive Craig Herkert as its CEO.

Herkert, 49, had been the head of Wal-Mart’s Americas division since 2004. International sales are Wal-Mart’s fastest-growing segment, and the position gave Herkert extensive retail experience that will help Supervalu, the fourth-largest U.S. grocer. Retiring Supervalu chief Jeff Noddle said Herkert would create value for shareholders. He’ll do it by following the tried and true Wal-Mart formula.

The Wal-Mart Way
Wal-Mart became the world’s largest retailer by delivering consumers the low prices they wanted. In Herkert’s first conference call as Supervalu’s CEO, he detailed his plans to improve not only pricing but the overall customer experience.

First, Herkert says, he’ll improve customer service and make Supervalu stores nicer to shop in, something Wal-Mart itself has been doing with “supercenter” remodels and by deploying smaller Neighborhood Market stores.

Second, Herkert will restructure Supervalu’s pricing. The problem: The high-low model. Supervalu stores offer deep discounts on a few items but charge relatively high prices on everything else. Instead, Herkert wants to offer everyday low prices. Sound familiar? It should: That’s Wal-Mart’s motto.

Besides, Herkert said, it turns out customers didn’t really fall for the limited discounts. Cost-conscious consumers didn’t come to the store for a deal on detergent and then stick around for relatively high-priced groceries. They go buy them somewhere else. But customers who believe a store is always going to offer the best price are loyal shoppers, something Wal-Mart has proven conclusively.

Changing the pricing structure will be costly and take time, but Herkert says it will be worth it.

Is Supervalu a Value?
Consumers have been trading down to less expensive items and using more coupons in this tough economic environment. This trend has affected most retailers, but it has killed the stores with higher price points. Supervalu’s revenue fell as consumers flocked to low-priced competitors. Herkert’s Wal-Mart background makes him the ideal leader to win back customers and turn Supervalu into a low-price powerhouse.

There’s only one way to turn around a grocery store: Increase revenue and reduce expenses. In a low-margin business, no competitor can improve its results by raising prices — customers will just go someplace else. The good news for Supervalu shareholders is that generating more revenue at lower cost is in the DNA of every senior Wal-Mart executive.

Debt, as we’ve seen the past year, can severely restrict options. So a top priority for Herkert will be to reduce Supervalu’s debt-to-equity ratio which stands at 85%. One possible source for the some of the cash this will require is to reduce its dividend payment, which is substantially higher than any of its competitors, and redirect the money to pay off debt. The dividend payment last quarter represented 65% of Supervalu’s net income. That money could build shareholder value, not just line shareholders’ pockets.

Herkert also already demonstrated that all options are on the table. He’s even willing to shed underperforming assets — a classic Wal-Mart play. Last month, Herkert sold 36 Albertson’s stores in Utah for about $150 million. Analysts cheered the move, which helped Supervalu meet its interest expense. Herkert has not ruled out selling other stores.

Supervalu looks cheap among its competitors based on fundamentals:

Company P/E Five-Year P/E Average % Below Average
9.3 14.4 -35.4%
10.5 15.0 -30.0%
5.5 11.7 -53.0%

From an earnings standpoint, no grocer can compete with Supervalu’s low share price. Although all grocers are trading at a discount to their five-year P/E, Supervalu’s shares have been hit the hardest.

They’re off -53% from their five-year average. There’s no guarantee Supervalu will revert to its five-year average, but with Herkert at the steering wheel, I wouldn’t bet against it.

Herkert’s planned changes will take time before they affect Supervalu’s bottom line. Analysts expect 2009 earnings to be on par with its 2008 results, and they forecast they will start moving on an upward track by 2010. Herkert says he will unveil Supervalu’s new strategy in October. Smart bet: Add them to your portfolio before then.

Phil Jackson was able to win a championship in his first year with the Lakers. Investors should be looking for a similar performance from Herkert at Supervalu. It’s not only a traditional value play, it’s a chance to own a company with tremendous turnaround potential that’s ready to beat Wal-Mart with its own playbook.