Tuesday, December 14, 2010

SuperValu: Leveraged Buy-Out For Retail Investors

Have you ever wanted to participate in a leveraged buyout (LBO), but lacked the capital, the management expertise, and the lenders willing to finance most of the purchase? You are in luck! SuperValu (SVU), at today's prices, has almost all of the characteristics of an LBO without actually being an LBO. This is an important distinction, because it gives you the opportunity to participate.

LBO's are best done on companies with consistent cash flows, as these cash flows will be relied upon to reduce the debt used to finance the purchase. SuperValu has got the cash flow consistency. Demand for groceries does not go away no matter what goes on with the economy, and as a diversified retail grocery chain (operating under a number of banners including Acme, Albertsons, Bristol Farms, Cub Foods, Farm Fresh, Hornbacher’s, Jewel-Osco, Lucky, Save-A-Lot, Shaw’s, Shop ’n Save, Shoppers Food & Pharmacy and Star Market), SuperValu has generated positive operating margins year after year with little fluctuation. (The red ink on the income statements reflects Goodwill write-downs from past purchases, and do not affect the company's cash flows.)

LBO's are also characterized by having a strong, motivated management team to increase efficiency. To that end, SuperValu hired away Wal-Mart's CEO of the Americas to serve as the company's chief executive. Since his hiring in 2009, the CEO has applied cash flows to pay down debt: in the last three quarters, the company has generated about $1.4 billion in cash from operations, and applied over $1 billion of that to debt repayment. He has also implemented initiatives aimed at improving operations, including centralizing marketing, reducing SKUs, and reducing prices. Eighty-six percent of his pay is performance based.

LBO's are also characterized by large debt obligations relative to equity. This is what allows for the large upside for equity owners (profits beyond what is needed to pay off debt accrues to a small amount of equity, resulting in the potential for big returns), but it also represents the biggest risk to the enterprise. Again, SuperValu fits right into the LBO pattern: the company has total debt of $7.1 billion, compared to a market cap of just $1.8 billion.

To understand the threat to SuperValu posed by the company's debt, it's important to consider how well the company is able to service its debt obligations. Interest coverage looks okay, as EBIT/interest is around 2, and EBITDA/interest is around 4. But principal repayments appear to be more of a threat, as some of the company's long-term debt is coming due quite soon. The following chart depicts the company's debt obligations over the next several calendar years:

The company only generates operating income of just over $1 billion, so the repayments due in 2011 loom quite large. Additionally, the company has a total of around $1 billion of capital leases due over the next several years which are not included in the chart above. But store refreshes are essential in retail, and this debt repayment schedule does not allow for much re-investment in the business, which is crucial to sustaining cash flow in the future. The company is also experiencing success with its Save-A-Lot banner, and therefore plans to spend capital to open a number of such stores in the coming year.

So how can the company meet its obligations and run the business successfully? Using its bank revolver. The company has a revolving line of credit expiring in 2015 under which it still has $1.7 billion available. As such, whatever it cannot pay off in 2011, it can borrow from the revolver. Adjusting the above chart for this revolver makes the debt schedule look as follows:

This gives the company a lot of breathing room in the near term. But it doesn't mean the company's debt is not a threat. What it does do, however, is allow the company to make the capital expenditures it needs to improve the business. Capex not required by the business (which appears to be most of the company's operating cash flow, judging from management's actions) can still go towards paying off debt.

Finally, the company has also been selling under-performing assets in order to generate cash. This helps both accelerate debt payments and make the company more profitable.

The price of the entire Supervalu enterprise (debt + equity) is around $9 billion, against earnings before interest, taxes and non-cash writedowns of about $1.1 billion, for an EV/EBIT ratio of about 8. Since SuperValu has both the breathing room and the cash flows to make the debt repayments and capital expenditures it needs to, the company should see an increase in the market value of its shares even if its enterprise value were to fall.

Disclosure: None

* The graph is an approximation based on the company's disclosures in its latest 10-Q.


Assaf Nathan said...

Hi Saj !

Thanks for the interesting find, i am a big fan of leveraged companies that write losses because of goodwill impairment (see for instance, ETM, CMLS, etc).

SVU currently trades at very low multiples. Given the company is deleveraging, some of the interest expense will free more cash - so the company will be able to repay even more debt.

In time, this will translate to more and more cash.
In 2 years the company can eliminate more than 25% of the debt, which means at least 100M more to net income.

This lowers the multiplier even more.

Why didn't you open a position ?

Saj Karsan said...

Hi Assaf,

I may open a position; it will depend on the rest of my portfolio and other ideas.

Assaf Nathan said...

By The way,

Your blog is excellent. Surely one of the best i know.

I like it that your posts are always short and to the point, very easy to read.

Also, you and my bro went to the same school together :)

Well done !

Saj Karsan said...

Thanks, Assaf. Which school is that? (There have been so many!!)

james moylan said...

I have a web site where I cover stocks under ten dollars.super value stores is a really under valued stock at 9.00 dollars a share the company has a market cap of only 2 billion dollars but does 40 billion dollars in annual sales. I think the stock could reach 90.00 dollars a share over the next five years yes I said 90.00 dollars a share In addition to this the company pays a dividend of almost four percent.

Assaf Nathan said...

The school I am referring to is Richard Ivy School of business.

Keep on the good work!

Wilhelm said...


The stock is taking a beating after dissappointing quarterly results. Seems like a decent time to buy, any thoughts on that?

Thanks for taking the time to keep this blog going, appreciate it.

Saj Karsan said...

Hi Willhelm,

It might just be. It depends on whether you can stomach all that debt.

Jaap van Duijn said...

Hey Saj,

I have a question. Is it possible that SVU could refinance their debt by issuing a new debt which matures in 2018-2025. It would make things easier for them but I don't know their lenders would accept it.

Saj Karsan said...

Hi Jaap,

Yeah I think they are doing that where necessary and possible, as per this note.

Anonymous said...

Hi Saj,
Despite beating estimates in the last couple Qs, they same store sales are still worrisome. a negative 3.9% number with at least 2-3% inflation means traffic,etc. is still declining more than 5%, which has been the same for 2 or 3 years. at some point they can't cut enough costs to make up for declining sales...the trend has to turn...the guidance for the year on comps isn't good considering there is 3% inflation built in.

Saj Karsan said...

Hi Anon,

I agree that that's a problem that needs to be addressed. But it is being addressed. As prices are reduced (relative to competitors), the same-store sales are turning. They were down 3.9% as you stated, but this is a sequential improvement from minus 5% last quarter. Also, the traffic situation may not be as bad as you think, as in response to inflation, customers are substituting to mitigate. From the conference call:

"It is important to note that the sequential quarter improvement in IDs from negative 5% to negative 3.9% was primarily driven by an increase in items per basket, as well as slight improvement in customer count. The increase in inflation in the first quarter compared to the fourth quarter was essentially offset by higher trade down."

Anonymous said...

Those are good points. its an interesting turnaround scenario. the thing that gets me nervous is that the ebitda margins are at 5.1% vs. Kroger at 4.6%, which tells me prices need to come down a lot in their conventional banners...they have to play this dangerous game of finding cost take-out to fund price reductions and hope doing so doesn't hurt the ebitda too much in the interim to breach covenants, etc. its difficult to know what the normalized ebitda should be for this company as they are balancing these cost savings with the need to take down prices. if normalized ebitda is closer to $1.5Bn, this company is not particularly cheap.

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