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Poor 1Q for Supervalu

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Supervalu Inc. (SVU), one of the largest grocery chains in the US, posted first quarter fiscal 2013 earnings per share of 19 cents, sharply lower than the Zacks Consensus Estimate of 38 cents and the prior-year quarter earnings of 35 cents a share.

The lower-than-expected results were due to the disappointing same store sales during the quarter coupled with disposition of several fuel centers owned by the company.

Revenues and Margins

Supervalu’s total sales dipped 4.5% to $10.6 billion in the first quarter of fiscal 2013 from prior-year sales of $11.1 billion. The reported revenue also missed the Zacks Consensus Revenue Estimate of $10.9 billion. Lower customer spending due to the ongoing economic challenges as well as aggressive pricing by the competitors negatively impacted the sales.

Gross margin contracted 10 basis points to 22.0% in the first quarter of fiscal 2013 on account of higher advertising spending and changes in business segment mix. These were partially offset by benefits from lower fuel sales and a lower Last In First Out (:LIFO) charge. Supervalu reported an operating profit margin of 2.0% during the quarter, compared with a margin of 2.5% in the prior-year quarter.

Segment Details

Net sales at Retail Food declined 6.8% to $6.8 billion in the first quarter of fiscal 2013, as compared with $7.3 billion in the prior-year quarter. Results were impacted by negative same-store sales of 3.7%, store closures and sale of fuel centers. Retail food operating margin declined 50 basis points in the reported quarter to 1.5% due to advertising expense, and the impact of sales deleveraging, partially offset by the company’s cost reduction initiatives.

Net sales at Save-A-Lot remained more or less flat at $1.29 billion compared with $1.28 billion in the prior-year quarter. The marginal increase was on the back of 53 additional stores being operated at the end of the first quarter. Save-A-Lot operating margin declined 80 basis points in the reported quarter to 4.6% due to negative same store sales during the quarter and increase in administrative costs

Net sales at Independent business marginally slipped 0.9% to $2.48 billion in the first quarter of fiscal 2013 compared with $2.50 billion in the prior-year quarter. Lower spending by the existing customers dented the sales of this segment. Independent business operating margin declined 50 basis points in the first quarter of fiscal 2013 to 3.1%, primarily attributable to restructuring costs.

Other Financial Update

Cash and Cash equivalents of Supervalu as of June 16, 2012 were $151 million versus $157 million as of February 25,2012. Long-term debt and capital lease obligations as of June 16, 2012 were $6.0 billion, as compared with $5.9 billion as of February 25,2012.

Initiatives for the Future

The company has undertaken a fair price plus promotion strategy, under which it aims to lower the pricing to match with its competitors. The company expects to do so by the end of fiscal 2013. Although this initiative may hurt short-term operating margins, yet it is expected to help the company gain market share in the longer term.

Moreover, the company has taken cost-reduction initiatives that are expected to lower an additional $250 million administrative and operational expense by fiscal 2014. This is in addition to the company’s current target of curtailing $75.0 million expenses for fiscal 2013.

With a view to increase its financial flexibility, the company plans to replace its senior credit facility with an asset-based lending facility and term loan secured by a portion of the company’s real estate. The company also plans to bring down capital expenditures to a range of $450.0 to $500.0 million in fiscal 2013 from $675.0 million, suspend the quarterly dividend, and reduce debt by $450.0 to $500.0 million in fiscal 2013.

Supervalu expects to complete remodeling of approximately 40 store and increase Save-A-Lot’s store count to 40 stores, including licensed locations.

Recommendation

We believe that the global economic slowdown is causing headwinds for Supervalu as well as its peers. Further, low disposable income of consumers is forcing these companies to spend cautiously. Moreover, the Food and Drug Administration (:FDA) is becoming more and more vigilant regarding food and health standards. Adverse publicity regarding food and drugs is affecting consumer confidence and preventing them from buying the company’s products.

Supervalu operates in a highly competitive market. Moreover, labor unions pose inherent risks for the company and potential labor related issues remain a concern. Supervalu faces stiff competition from Wal-Mart Stores Inc. (WMT), The Kroger Co. (KR) and Safeway Inc. (SWY).

However the long term initiatives taken by the company can help the company in gaining market share over its competitors, reduce costs and increase value to the shareholders of the stock.

Currently, the stock carries a Zacks #3 Rank (short-term ‘Hold’ rating) on Supervalu. However, we have a Neutral recommendation on the stock over the long-term.
 

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