Supervalu Faces Price Challenges

ELLIOT ZWIEBACH

MINNEAPOLIS — With food retailers facing the prospect of rising inflation, analysts challenged Supervalu here last week about how it proposes to lower pricing and be more effective on promotions.

In a conference call, Craig Herkert, president and chief executive officer, outlined the directions Supervalu hopes to move to reverse its negative trajectory, including analyzing business processes to maximize efficiencies and get a better handle on everyday pricing and promotional offers.

“Our company remains in control of its future,” he said. “We are aggressively addressing the operational issues that have led our customers to divide their basket and select against us.”

But his optimism was repeatedly challenged by analysts after the company reported losses and declining sales for the third-quarter and 40-week periods that ended Dec. 4 and lowered its financial guidance for the second quarter in a row.

Mark Wiltamuth, an analyst with Morgan Stanley, New York, said Supervalu is not getting a response from the shift to price cuts and promotions it has already made.

“We're concerned that ‘catch-up’ price cuts often result in sales and margins getting worse in the near term,” he noted. “We are also concerned the company's decision to shift to price cuts will collide with inflating good costs, resulting in margin shortfalls.

“While we don't believe inflation has fully arrived, the impact from price reductions has, with Herkert saying the company invested heavily in promotional activities that proved to be less than effective.”

According to Ajay Jain, senior analyst at Hapoalim Securities, New York, “Supervalu remains a very structurally challenged company, and lowering its guidance again after doing so in the second quarter doesn't read well because it raises a variety of concerns about whether the management team can execute properly and whether it can make the necessary changes to reverse the earnings trajectory, which is in free-fall right now.”

Karen Short, an analyst with BMO Capital Markets, New York, said Supervalu faces “a long and winding and challenging road,” noting that negative identical-store sales are “largely traffic driven and unlikely [to be] recoverable, and the outlook remains uncertain.”

Scott Mushkin, an analyst with Jefferies & Co., New York, also said Supervalu faces “a difficult road ahead” and suggested management may want to consider asset sales.

“While rationalizing assets is not always the best answer, the true level of capital required or price investment needed to return some banners to more competitive positions remains unclear,” he said. “At this stage, with pricing still out of line, significant market-share erosion and what we believe is the loss of brand relevance, the board and management need to take a hard look at whether these assets should see further capital and price investments.”

The loss for the 12-week third quarter was $202 million, with sales dropping 5.9% to $8.7 billion and identical-store sales in the retail food division falling 4.9%. For the year to date the loss was $1.6 billion, while sales fell 8% to $28.9 billion.

Based on third-quarter results, Supervalu said it was lowering its financial guidance for the year, projecting a net loss in the range of $7.19 to $7.09 per share, with food sales likely to decline approximately 3.5% and ID sales expected to drop to negative 6%.

Herkert said third-quarter ID sales at its three Northeast banners — Acme Markets, Philadelphia; Shaw's Supermarkets, West Bridgewater, Mass.; and Shoppers Food & Pharmacy, Bowie, Md. — were down in the high single digits, while IDs at Jewel in Chicago were slightly above the overall corporate decline. Those results prompted Supervalu to decide to close 15 underperforming stores in the Northeast next month and to offer buyouts to associates at Acme, with plans for a similar offer at Shoppers, he added.

Given the sales declines in the Northeast, one analyst asked Herkert, “What makes you think the problems at these banners are actually fixable?”

“Clearly in some parts of each banner we have some challenges,” Herkert replied. “But we have leading market shares in each banner, and we have very, very successful stores within each banner. So at the granular level we know [implementing certain initiatives] works.”

“I'm in a lot of your stores, and I haven't seen anything like that working,” the analyst shot back, to which Herkert replied, “I travel every week to visit stores, and I actually see a lot of good things going on out there — clearly not at the level we need, or we would have better results right now. But the engagement we get from our store directors and department managers with their newfound authority to do things locally is really powerful.”

The analyst followed up by asking how Supervalu can bring pricing in line with competitors and draw people back into its stores after lowering prices in the third quarter and still failing to meet competition.

“It involves a very thoughtful process of fixing things granularly,” Herkert said. “We are not going to take broad swaths of the business and do some sort of Big Relief price cut. What we are doing is being very methodical, going item by item, sometimes category by category, and getting our prices in line.”

SOME FAVORABLE TRENDS

In instances where Supervalu banners have made changes — for example, offering fully stocked dinner solutions at peak business hours; just-baked breads; or price reductions exceeding 30% in meat and seafood — “we've begun to see favorable sales and margin trends,” Herkert said.

“The great news is, we have a lot of customers coming through our stores every day, and we've found that when we get prices in line, we see they are willing to buy that product on a regular basis. As we lower prices, we are communicating it very clearly in our stores that we've done something different, and customers are responding to it. But none of this happens overnight, though we clearly expect to see benefits in the next fiscal year.”

Asked about the size of the benefits, Herkert replied, “That's not something I want to disclose, but it's significant.” When one analyst noted that Supervalu's EBITDA margins are well above those of Kroger Co. or Safeway — “which implies you have a long way to go to get more in sync with your conventional competitors,” the analyst said — Herkert replied, “We agree that we have a multi-year journey to get all our prices in line with where customers expect them to be.”

Asked about possible asset sales, Herkert said, “As I've said in the past, we will always look at our asset base and make appropriate decisions for our shareholders. Clearly there has been a change in competitive activity in many markets. But the business transformation [Supervalu has underway] will better position us to win going forward and better position us in each banner.”

Herkert acknowledged that Supervalu conducted a series of ineffective promotions during the third quarter, specifically on carbonated soft drinks, soups and frozen categories.

“There are specific places where we did not run promotions effectively,” he said. “But there are other places where we ran effective promotions, and the good news is, we have new tools and new processes to really be much more thoughtful about which promotions will actually cause customers to come into our stores and improve their basket and their loyalty and not just come in to buy specific items on promotion and then do their whole basket trip elsewhere.”

Herkert said many of the new tools and processes are coming from a retail consulting firm Supervalu hired during the third quarter, which the company declined to identify.

“A dedicated team is in place to work across the business to track key work streams that we've identified,” Herkert explained, “and we are beginning to track progress on these work streams with structured scorecards that measure results based on timeliness, efficiency and financial impact.

“For example, since mid-December we've been implementing advanced promotional analytics and planning tools that give us much better insights into the full impact of weekly ads on both sales and margins, which should help us get a better return on promotional investments.”

The company is also taking a more holistic approach to planning weekly ads to ensure a balance between driving trips and managing margins, Herkert noted, “and the new analytics give us a better handle on temporary price reductions to better determine the proper price point and timeline for those programs as well as the appropriate vendor funding to support those promotions.”