Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Grocery Wars

Can Supervalu Survive??

Some financial reports raise the obvious question: how can this company survive? A prime example of such a troubled firm is Supervalu (NYSE: SVU), the Minneapolis parent of Cub Foods.

Supervalu shareholders lost $258 million in equity during the third quarter of 2016, ycharts data indicates. That loss came from a stock that was selling for $3.35 a share on March 21, 2017. That gave shareholders a one month return on price of -15.54%, a year to date price return of -30.19%, a one year return of 43.30% and a three year price return of -50.30%.

Supervalu shareholders are losing money every time the market opens and it is easy to see why. Supervalu reported a “profit margin” of -.87% and a free cash flow of -$70 million on November 30, 2016. That further punished investors with a return on equity of -27.25% on the same day.

Surprise Supervalu is Making Money

Despite all that Supervalu is actually making money. Surprisingly it reported a net income of $103 million and $388 million in cash from operations on November 30, 2016.

The company’s revenues were also considerable $19.58 billion on November 30, 2016. Larger than market darling, Whole Foods (NASDAQ: WFM) which reported revenues of $15.81 billion on January 31, 2016.

Supervalu’s revenues also grew over the past year rising from $16.9 billion in November 2015 to $19.58 billion a year later. That’s an increase of $2.68 billion which is very impressive.

The Grocer’s Dilemma

Yet this also displays the dilemma that grocers are in it is possible to generate a lot of revenue in the grocery business but hard to accumulate cash or float. Supervalu reported cash and short-term investments of $47 million on November 30, 2016.

To make matters worse its liabilities of $4.732 billion exceeded its assets of $4.474 billion on the same day. That indicates a company close to the death spiral which is driving all the speculation that Kroger (NYSE: KR) is planning to buy Supervalu.

Disturbingly Kroger might have no choice but to buy Supervalu because it needs all the revenue it can get. Kroger reported a free cash flow of just $142 million and net income of only $1.96 billion off of $115.34 billion in revenue on January 31, 2017. That translated into cash and short-term investments of just $322 million on the same day.

Kroger’s assets of $36.50 billion also exceeded its liabilities of $29.8 billion at the end of the last quarter. It was only able to achieve that by acquiring a vast footprint and generating a huge amount of revenue.

Supervalu is a Great Investment – For Kroger

Kroger is demonstrating that the only way to survive in the grocery business is to generate as much revenue as possible. Were Kroger to acquire Supervalu it would get $19.58 billion in revenue for an investment of $883.27 million (SVU’s market Cap on March 15, 2017).

Even if Kroger had to pay the full enterprise value of $3.183 billion for Supervalu it would get nearly $20 billion in additional revenue. That sounds like a great deal to me, which is why observers expect Kroger to move on Supervalu.

There are some other reasons for Kroger to acquire Supervalu, its Cub Foods brand is the dominant supermarket in a major metropolitan area – Minneapolis and St. Paul. Minnesota is a state that Kroger has not penetrated, but it is adjacent to Kroger markets in Illinois and Wisconsin.

Some of Supervalu’s other operations such as Shop n’ Save in Central Illinois and Shoppers and Farm Fresh in Maryland, Virginia and Washington DC; would fit in well with Kroger’s existing operations. A Supervalu acquisition would also help Kroger penetrate another major metropolitan area; St. Louis, and increase its operations in two others; Washington DC and Baltimore.

Income Inequality Explains why Kroger might be reluctant to buy Supervalu

My guess is that the only thing blocking a Kroger acquisition of Supervalu is its Save-A-Lot subsidiary; which operates 1,300 franchised discount grocery stores.

Save-A-Lot is very vulnerable to income inequality and wage stagnation which are growing dramatically in America. The Pew Income Study found that the wealth of average middle class family in the US fell by 28% between 2001 and 2013. Pew also found that the rich are the fastest growing class of Americans, the percentage of Americans in the highest income bracket increased from 7% in 2001 to 8% in 2011 and 9% in 2015.

This explains why Kroger is investing so heavily in upscale grocery brands; like Harris Teeter, Lucky’s and Maine and Vine, and its’ swank Marketplace Stores – that feature such amenities as gourmet cheese shops, wine bars and Asian bistros. This also explains Kroger’s interest in delivery and online ordering of grocery including a partnership with Uber. It is the reason why Kroger is quietly closing traditional supermarkets in some middle and working class neighborhoods.

One obvious reason why Kroger is following such a strategy is that upper-income shoppers buy more expensive goods and spend more. That generates more revenue which Kroger desperately needs.

Kroger’s executive team; which is quietly dumping the middle class market, might think Supervalu has too much of a working class focus. Although Supervalu has a lot of assets including the Cub Foods stores that can easily be reconfigured to serve a more upscale market. Kroger successfully converted some Cub Foods locations in Denver into King Soopers Marketplaces.

Therefore my take is that Kroger would only buy Supervalu if it would dispose of a lot of the company’s assets. That might be very difficult given the state of the grocery industry. Save-a-Lot in particular faces aggressive competition from Kroger, Aldi, Walmart (NYSE: WMT), Safeway and the dollar store chains.

Supervalu might be a good investment for Kroger; but it is certainly a lousy investment for anybody else with the possible exception of Safeway.

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