This Undervalued Company's Expansion Could Spell Big Gains

Francisco Bermea's picture

Tuesday, January 26, 2010 - 9:14am

by Francisco Bermea

The fourth-largest grocer in the United States was in trouble.

Its debt was growing and its earnings were shrinking, an unsustainable combination. It needed a turnaround -- and quick.

That's exactly what Supervalu (NYSE: SVU) got when last May it hired Craig Herkert, former head of Wal-Mart Stores, Inc's (NYSE: WMT) Americas division.

Herkert's top priorities when he became CEO were to cut expenses and cut prices.

Wal-Mart became the world's largest retailer by delivering consumers the low prices they wanted. Herkert's first move as CEO was to move away from the high-low pricing model used in most Supervalu stores. Consumers didn't come to the store for a deal on one product and then stick around to purchase other relatively high-priced items, especially during a recession.

Instead, Herkert uses Wal-Mart's playbook and is changing the pricing scheme to everyday low prices. Customers who believe a store is always going to offer the best price are loyal shoppers, something Wal-Mart has proven conclusively.

SuperValu shares are trading at a -47.2% discount from their five-year average. Herkert seems to think they are a good deal; he just bought 25,000 shares, recent SEC filings show.

Supervalu's sales were $9.2 billion in the third quarter ended Dec. 5, 2009, slightly less than $10.2 billion in the previous year. Some of the decline can be attributed to closing underperforming stores.

Selling assets helped offset Supervalu's selling and administrative expenses, reducing the total to $1.75 billion from $1.92 billion a year ago. Supervalu also cut its total liabilities by -6.7%, which saved the company $12 million in interest expense.

The company's cost cutting efforts paid off. Despite soft sales, Supervalu exceeded analysts' estimates and increased its earnings to $109 million, compared with a $2.9 billion loss the previous year.

Supervalu's goal is not just to become more efficient by cutting costs. The company recently said it plans to aggressively expand its discount grocery chain, Save-A-Lot. The company has about 1,200 Save-A-Lot locations and it plans to double that figure during the next five years.

The Save-A-Lot retail chain is an everyday low price operator. It's a limited assortment retailer, meaning it focuses on top selling items, and operates stores that are smaller than the typical supermarket. Its cost advantage allows it to keep prices low and still be profitable.

It's not just frugal shoppers that will benefit from expansion. The new Save-A-Lot discount stores will diversify its current portfolio of about 1,300 traditional grocery stores. The company's revenue should be more resilient during economic downturns as penny-pinching consumers try to conserve cash.

Supervalu recently cut its quarterly dividend from $0.18 to $0.09. The cash will help pay for Supervalu's new discount stores and pay down its debt. The money will build shareholder value in the long run, instead of lining investor's pockets in the short-term.

Even with the dividend cut, the shares yield 2.3% and look cheap based on fundamentals.

Company (Ticker)

P/E 5-Year P/E % Below Average
Supervalu (NYSE: SVU) 5.6 10.6 -47.2%
Safeway (NYSE: SWY) 10.6 14.5 -26.9%
Kroger (NYSE: KR) 12.2 15.5 -21.3%

The recession has been difficult for grocers, especially for those with high price points. Consumers have been trading down to less expensive items and flocking to low-price vendors. Supervalu's transformation into a low-price operator could prove to be a strong profit catalyst for the company (Catalysts are the reason 42 out of 52 of these stocks are up). Investors with a long-term investment horizon could follow Herkert's lead and pick up shares at a discount.

Francisco Bermea does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.