In the spotlight: Supervalu's long hard slog
By Dean Best | 12 April 2012
It will take time for Supervalu, which has chains including Save-a-Lot, to see its transformation programme pay off
US retailer Supervalu saw its sales and gross profit fall yet again in its last financial year although CEO Craig Herkert insists progress is being made. Analysts acknowledge the company is on the right track but argue it could be years before it yields the full benefits of its moves to revitalise the business. Dean Best reports.
The last year has been yet another challenging one for Supervalu Inc, one of the largest retailers in the US.
The company, which has a network of over 4,300 stores across the country, embarked on the first year of a "transformation programme" under CEO and president Craig Herkert. The programme has included moves to tailor the products on sale in stores to their local customer base and improve the perception of its prices among consumers.
However, for the third consecutive financial year, Supervalu has seen its gross profit, revenue and its identical-store sales fall. It has been 12 months in which Supervalu's shares have plummeted by more than a third, no doubt hit by rumours that the retailer could break lending covenants and even fall into bankruptcy. There has also been talk that the company could be a target for private-equity firms.
Speaking after Supervalu announced its latest annual financial results on Tuesday (10 April), Herkert claimed the company had made progress and had built a "strong foundation" on which to build and push on with the programme.
In the last three months of the financial year, which ran until 25 February, identical-store sales were down 1.9%, compared to a 2.9% fall in the third quarter of the year. Customer traffic improved quarter-on-quarter. Costs were brought down, leading Supervalu to beat Wall Street forecasts on its underlying earnings per share and Herkert to say that Supervalu had strengthened its balance sheet. And, in store, the Supervalu chief said the retailer's moves to invest in its produce department had started to pay off.
BMO Capital Markets analyst Karen Short acknowledges Supervalu has made progress but she says it has been "slow". She argues Supervalu's current transformation programme has been hampered by mistakes that Herkert, a former Wal-Mart Stores executive, made after he joined in 2009.
"They have had fits and starts. From the time that the CEO arrived he embarked on one strategy of reduce inventories and think of their customers by geography instead of looking a strategy by banner," she says. "His initial approach to fixing Supervalu was very Wal-Mart-ish and is not something that is going to work for a conventional supermarket. Each banner has its own identity and brand equity. All of Supervalu's banners were losing share because their banners were not resonating with the customer anymore. His initial attempt to fix didn't work so then he had to reverse course and that involved putting inventory back in the store and going with this hyperlocal buzzword. In the meantime, they've lost a couple of years."
The year ahead, Herkert insisted, would be one of "focused execution". He said: "We will focus on three priorities: one, improving our value proposition; two, bringing an even greater hyperlocal experience to the neighbourhoods we serve; and three, driving long-term growth. We enter the new fiscal year as a leaner company, committed to a business strategy that will make us a more competitive retailer."
Supervalu's shares increased after its results announcement on Tuesday and its forecast that earnings per share would improve in the new financial year. The retailer is seen as having enough liquidity and as unlikely to break lending covenants. However, if and when the retailer sees the full benefits of its transformation programme is an open question on Wall Street.
"It will likely take several years before price investments have a significant impact on customer perception or sales," Barclays Capital Meredith Adler said in a note to clients yesterday. "Supervalu's expectation is that existing customers will recognise the lower prices first and the initial sales benefit will be visible in the average basket. Eventually the overall perception of the prices at Supervalu should improve and help the company win back former customers or attract new ones. It has convenient locations in many of markets and well-recognised – if somewhat tarnished – brand recognition, so traffic has a real potential to increase. In our long experience, however, it can take multiple years before consumers in a market recognise that everyday prices have been lowered and sales improve."
And that challenge is all the more difficult when consumer confidence is fragile and a number of retailers, not just Supervalu, are looking to emphasise the value that they can offer shoppers. Scott Mushkin, an analyst at Jeffries & Co., pointed to signs that rival retailers Kroger and Delhaize, which owns US chains including Food Lion, were focusing more on price and, on Supervalu's conference call with analysts on Tuesday, asked Herkert if trading conditions were set to become more challenging. Herkert insisted the environment was "not wildly outside the norm" but there is no doubt Supervalu, while it looks to conserve cash and reinforce its balance sheet, will need to maintain its own moves on price and promotions.
"They are probably on the right track because they have had some decent improvement in their two-year same-store sales trends even though they are still pretty weak," Short says. "But they're dealing with a balancing act of preserving some component of their profitability so they can pay down debt and investing in price, so they really can't move the needle very much and very quickly because they have to maintain their cash flow," Short says.
To pay down debt, Supervalu could, of course, look to offload assets as it did in 2010 when it sold its Bristol Farms division in California and its logistics and supply chain subsidiary Total Logistic Control. However, Short argues more deals would have been done by now. "I would have thought by now they would have. Either they are not interested or their expectations are unrealistic, or there is no buyer. It would have seemed like a logical strategy."
On Tuesday, Herkert faced a question over whether Supervalu would consider spinning off its Save-a-Lot discount stores as a way of boosting value for shareholders. He declined to comment directly and would only say: "Management and the board have a regular process of reviewing the business, the business performance and the best way to achieve shareholder value."
Short believes a spin-off would not benefit shareholders. "If they spun out Save-a-Lot, the proceeds aren't going to go to the equity holders, they are going to go to the enterprise value of the company. Any proceeds you could get would go to pay down debt. In doing so, the shareholders would be rewarded because the debt levels come down but spinning out Save-a-Lot and saying that the company is trading at less than what Save-a-Lot is worth is not the right math," she says.
How can Supervalu improve value for shareholders? "Supervalu has to continue plugging away. It's going to be slow and steady," Short says. "They have to keep paying down debt. People need to feel comfortable that there's no covenant issue. Even if there were a covenant issue, you can have your covenants revised. They do have one or two more step ups in their covenants. There might be a quarter where it might be looking a little close depending on how they are doing with their turnaround. I don't think it's the highest of probability that there will be a covenant issue."
All the while, Supervalu embarks on the second year of its transformation programme, insisting it is making progress and that more will be made in the months ahead. As things stand, the retailer is not a broken business and things are improving, albeit slowly. However, the trading environment remains tough and competitors aggressive, not ideal conditions to revitalise a business.
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In the spotlight: Supervalu's long hard slog
12 Apr 2012 -