The grocery store business has been fiercely competitive in the last few years with consumers eating out less during the recession. Today, Safeway (SWY) announced that it would likely miss current fiscal 2010 earnings estimates mainly because of lowering prices to better compete against industry rivals. This more conservative guidance for Safeway was not at all unexpected though as the stock has regained much of the losses in afternoon trading, but we believe there is a much more attractive stock than Safeway even in an industry where margins are squeezed and competition from warehouse retailers threatens.
Supervalu (SVU) is one of the largest national grocery store chains and operates under various brand names including Albertsons, Shaw’s and Save-A-Lots. SVU stock has greatly underperformed the market over the last year thanks to industry competition and food price deflation, and the comparably high debt load has caused Supervalu to lag many of its closest competitors. However, we think there are reasons to believe that better times are indeed ahead. For example, in January SVU reported fiscal third quarter earnings results that showed EPS of $.46 easily topped estimates of $.40 despite underachieving sales. The company was able to maintain profit margins of 22.3%, which is of extreme importance with food price lower than they were a year ago. One of the ways that they are achieving those margins is through better inventory management and reducing the number of items in stores to reduce costs. Strict inventory management is essential to grocers and should show up in the bottom line results.
Furthermore, interest expenses declined 8.4% as result of reduced borrowing as well as lower interest rates. Continued reduction in debt will be a large part of the solution to SVU in the future. They were a victim of poor timing with their expensive bid ($17.8 billion) for Albertsons just before the economy tanked. The results was a highly leveraged company that needed to spend money servicing debt and consolidating operations rather than refreshing stores, as their competitors were doing.
Supervalu management expects the company to earn $1.95 to $2.05 in fiscal 2010 which ended in the month of February, and consensus analysts’ estimates have the company pegged for $1.95. Assuming earnings come in on the lower end of management’s guided range, the stock is currently trading for just over 8x this year’s earnings. Furthermore, when looking at price-to-cash earnings SVU currently trades at 3.04x, which falls well below the historically normal range for this stock of 4.51x to 7.06x. Similarly, despite the slumping sales the stock trades at a price-to-sales of .08x, which falls below the normal range of .13x to .20x. Clearly, we see a fair amount of appreciation potential in this stock and currently have an Undervalued rating on it.
Of course, we still have concerns with Supervalu’s debt load (mainly from the acquisition of Albertsons), especially at a time where sales are falling. However, on the whole, the stock is extremely cheap and should be of interest to value investors. CEO Craig Herkert, who was brought on less than a year ago from Wal-Mart (WMT), has been hired to reinvigorate the company and spearhead the turnaround. Apparently he likes what he is seeing so far, as he added to his stake in the company by buying 25,000 shares in January following the earnings release.