Description

LONG Supervalu (SVU)

Stock Price: $4.20

Market Cap: $900 mm

Average Daily Value Traded: $15-$20 mm

Thesis

Supervalu is finally a super value; it is a levered special situation equity trading at 6x EBITDA and 3.5x FCF with a new owner and management team (Cerberus). We believe the new SVU has stable and growing EBITDA which means that the equity is too cheap on current numbers and could be a multi-bagger if Cerberus is successful.

We believe SVU will begin to re-rate as the company begins executing on the business plan and the numbers become more transparent. Given the financial leverage the opportunity for the equity is significant; once the market believes in the new management team and the forward projections we SVU will trade to at least 6.5x EBITDA on CY 2014 estimates. Including the 2013 FCF generation, this results in a target price of $7.75 or 85% ups from here.

Business Description

SVU historically was a small grocery chain and a wholesale distribution business to independent grocers. In 2006 SVU levered up to buy the majority of Albertsons. Since 2006, SVU has struggled to run these new stores competitively as their balance sheet prevented them from being competitive on price. The declining market share, profitability, and balance sheet issues came to a head in H2 12 when SVU announced a massive guide down on 2012, fired the CEO, and announced they were pursuing strategic alternatives.

In January 2013 SVU announced they were selling the Albertsons stores to Cerberus for $100 mm and the incurrence of the existing debt at the Alberstons entity level. Coincident with that transaction, Cerberus will invest $250 mm through a tender offer for 30% of SVU’s stock. Cerberus is putting in Bob Miller as Chairman of SVU and Sam Duncan as CEO.

The new SVU will be three separate businesses of ~equal profitability contribution: the legacy SVU grocery banners pre-Albertsons, the whole distribution business, and their hard-discount concept Sav-A-Lot. PF FY13 (ending 2/28) EBITDA is $752 mm, and projections for FY14 and FY15 call for EBITDA of $794 mm and $825 mm respectively. This growth in EBITDA comes primarily from cost cutting at the corporate level following a de-centralization of the business model. Management is not expecting anything heroic on the top line, but they are assuming revenue is stable from here.

The remaining grocery banners have had stable SSS and growing EBITDA for the past 3 years. The distribution business has had weak trends in the last few quarters but we believe this is due to the uncertainty about SVU’s future which resulted in management not passing through cost inflation through price increases which squeezed margins. This should be an easy fix with the removal of business uncertainty at SVU. Sav-A-Lot has also had weak trends recently and this will be more of a work in progress as past management allowed pricing to become ~300-400 bps uncompetitive so price re-investment is needed amongst other changes. Importantly, it is the company-owned stores that are underperforming; the franchise locations continue to execute, leading us to give new management the benefit of the doubt on fixing the issue vs. concerns that it is a more structural issue. In addition, SAL is in the right part of the grocery industry (hard discount) and is the biggest growth opportunity for SVU in the medium term.

Reason for Mispricing

There are a myriad of reasons for why SVU is mispriced: 1) The stock is down 70% in the last 2 years and has smoked any value investor buying into the cheap FCF multiple  2) the sell side has abandoned coverage of the stock given the poor experience they had with the company for the last 3 years, and the deminimus market cap today  3) SVU has morphed from primarily a grocer to a hodge podge of 3 different businesses  4) the financials are complex with the Alberstons transaction, the primary source of relevant financial data comes from a lender presentation with PF segment results and the tender off document with projections for the next three years  5) there is uncertainty over the stock technicals with the Cerberus tender offer currently outstanding (expires March 20^th).

Valuation

At $4.20/share, the market cap is $900 mm. PF for the Albertsons transaction and debt refinanging, net debt is $2.9 b. There is $1.6 b of corporate and multi-employer pension that we tax-affect to arrive at a total enterprise value of $4.9 b. This is 6.1x CY13 EBITDA based on company projections.

There is a misperception right now that FCF is $175 mm for CY13 based on comments from the CFO on the conference call discussing the Cerberus transactions. Management has since clarified their assumptions, and using the correct information we believe actual FCF is closer to $275 mm or $1.25/share. This implies SVU is currently trading 3.4x FCF. Companies that are stable/growing won’t stay at this low a multiple of FCF for long.

Based on market multiples for the three segments we think the right blended EBITDA multiple for the business is 6.5x which is a $5.50 target price on CY13 and $7.75 stock price on CY14 (including $1.25 of FCF in 2013). Note that underlying FCF easily supports these equity valuations.

Management

Management is an important element to our thesis. Cerberus is installing Bob Miller as Chairman and Sam Duncan as CEO. Bob Miller is CEO of Albertsons LLC (ABS) which has been a homerun investment for the Cerberus.  ABS bought the Albertsons stores that SVU didn’t want in the original 2006 buyout and was able to stabilize SSS and grow EBITDA while monetizing real estate of select stores. The original ABS investors are rumored to have received a 4x return on their initial investment. Bob Miller believes he can run a similar playbook at SVU and has drafted his former lieutenant Sam Duncan out of retirement to execute the plan. While Duncan is not a Jim Collins built-to-last kind of CEO, he has been successful at cutting costs at Shopko and OfficeMax which is the necessary skillset at SVU today. Given the track records of Cerberus, Miller, and Duncan, we are willing to give them the benefit of the doubt in executing the restructuring of SVU to drive EBITDA higher.

Catalysts

• Closing of the Cerberus tender offer.
• Management engagement with the buy side and sell side to communicate the new story.
• Several quarters of new financials published PF for the Albertsons transaction that shows a path to ~$800 mm of EBITDA for CY13 and growth in 2014.
• Potential asset sales – SVU has a large (size is still undisclosed) capital loss carry forward that will allow them to sell their business segments in a tax-efficient manner. We know from the strategic review process that KKR and others were interested in acquiring Sav-A-Lot and we know that C&S was interested in acquiring the distribution business. We think that ultimately Cerberus will look to spruce up the profitability of the company and then sell off the businesses to maximize value to shareholders.

Risks

We are relying heavily on the PF disclosures and management’s projections and commentary. They could be wrong. If EBITDA is lower than $750 mm and looks set to decline the stock will go down.

In this downside scenario it’s important to note that SVU’s new debt structure has zero financial covenants and no maturities until May 2016. At a minimum SVU has 3 years to execute the business plan.

Catalyst

• Closing of the Cerberus tender offer.
• Management engagement with the buy side and sell side to communicate the new story.
• Several quarters of new financials published PF for the Albertsons transaction that shows a path to ~$800 mm of EBITDA for CY13 and growth in 2014.
• Potential asset sales – SVU has a large (size is still undisclosed) capital loss carry forward that will allow them to sell their business segments in a tax-efficient manner. We know from the strategic review process that KKR and others were interested in acquiring Sav-A-Lot and we know that C&S was interested in acquiring the distribution business. We think that ultimately Cerberus will look to spruce up the profitability of the company and then sell off the businesses to maximize value to shareholders.