Supervalu Scales Back Its Growth Projections

ELLIOT ZWIEBACH

MINNEAPOLIS — Supervalu here saw its stock price plummet last week after the company scaled back its projections for sales and profit growth and acquistion synergies.

In a conference call discussing results for the third quarter, which ended Dec. 1, Supervalu said the synergies from its 2006 acquisition of Albertsons may not be realized until 2010, about six months later than originally expected.

Analysts, however, said Wall Street's negative reaction may have been overblown.

John Heinbockel, an analyst with Goldman Sachs, New York, said he believes the market overreacted when shares lost nearly 16% of their value on the day of the announcement, and continued to trade down another 4.5% the following day, to $27.31, taking them below pre-acquisition levels.

“We are surprised at the magnitude of this weakness [in the share values],” he wrote. “Operating results were certainly not as bad as they could have been, with comps positive and six out of 12 divisions posting comps of 1% or better.”

The drop in Supervalu's stock price “seems to be a commentary on how bad sentiment is for retail stocks, especially defensive names that no longer feel defensive,” he said.

“Investors are clearly concerned that soft sales trends may result in pressures on operating margin and earnings per share. But as long as comps remain positive, we would expect merger synergies to drive overall operating margin expansion. And even if comps turn negative, necessitating increased investments, we would not expect earnings to dip much below $3 per share.”

Heinbockel said he remains confident Supervalu is on track. “The comp, although well below peers', was hardly disastrous. In fact, it remains adequate to enable management to avoid having to meaningfully accelerate gross margin investments. Simply put, Albertsons is being integrated carefully and with few major missteps.”

Perry Caicco, an analyst with CIBC World Markets, Toronto, also said he felt the market's reaction was too strong.

“The market reaction has been too violent,” he wrote. “Although progress is delayed, earnings damage is minimal. Rocky quarters in an integration of this size and scope are to be expected. This does not mean the acquisition was a mistake [but] simply a delay of the inevitable. This management team will eventually get it right.”

Jason Whitmer, an analyst with Cleveland Research Co., Cleveland, told SN Supervalu's results did not justify such a big sell-off.

“But investors typically react to what's ahead rather than what's already happened,” he said. “They look for good news to surface, and there wasn't a lot of short-term good news from Supervalu. They usually evaluate a company's prospects in 12-month increments, and they're not very patient with three- to four-year stories.”

Supervalu achieved record earnings for the 12-week third quarter of $141 million, an increase of 24.8% over the prior year, while sales fell 4.2% to $10.2 billion — due to one less week of the acquired operations this year than in last year's quarter and also to 76 store closures over the last 12 months that were not offset by new stores; identical-store sales, excluding fuel, rose 0.5% in the quarter. For the year to date, net income rose 31.6% to $437 million while sales rose 24.2% to $33.7 billion.

Supervalu lowered its guidance on fourth-quarter earnings by 6 cents a share, to a range of $2.71 to $2.77, “because we have better visibility into the timing of our synergy-related activities,” Jeff Noddle, chairman and chief executive officer, said.

It also lowered its forecast on ID sales for the year, excluding fuel, to a range of 0.5% to 1%, compared with previous guidance at the lower end of the 1% to 2% range “as we anticipate a more cautious consumer,” he explained.

Noddle said Supervalu still expects to achieve IDs of 3% or more by fiscal 2010 as its aggressive store-remodeling program and merchandising efforts kick in.

Synergies Delayed

Speaking with analysts during the conference call, Noddle said Supervalu expects to realize the full measure of its post-acquisition synergies — $150 million to $175 million — in fiscal 2010, approximately six months later than its original target of fiscal 2009. “Otherwise we think we are exactly on the time frame we laid out,” he said.

The anticipated delay will result from the company's decision to implement a new retail-based systems platform for both its acquired properties as well as its legacy stores, he explained.

When Supervalu set a thee-year goal to achieve post-acquisition synergies by fiscal 2009, it did not yet fully understand Albertsons' merchandising procurement system, Noddle said. Once it did, “we had a choice to make — to bring the [two store groups] to one standard platform with a quick resolution or to take the time to do it right for the long term,” he said.

“It is just going to take more time to convert two companies rather than one, and that is clearly the right decision.”

Analysts said they were surprised that the synergies for this year will be only $40 million — at the low end of the range of $40 million to $50 million Supervalu had been forecasting.

“The company had assumed systems would be adequate to manage the combined businesses, which has turned out not to be the case,” Caicco said. “Supervalu is struggling to deliver even the easiest portion of the synergies — leveraging the combined purchasing power — because of an inadequate IT platform.

“That's why the company has only produced $40 million in synergy savings this [fiscal] year, when around $70 million would have been expected.”

While acknowledging that some of the gross synergies could be eaten up by the significant price investments Supervalu needed to make for Albertsons to become more competitive, “there should be bigger numbers here, at least over the medium term,” Caicco said.

Deborah Weinswig, an analyst with Citigroup Global Markets, New York, said the synergies of “just $40 million” will come primarily from cost-of-goods savings and lower corporate overhead costs.

But she expressed caution about future progress. “The timeline of Supervalu's transformational story has lengthened, and we remain concerned about future pricing pressures,” she wrote. “We recommend investors stay on the sidelines until fundamentals improve.”

During the conference call, Noddle said capital investments in the 2009 fiscal year that begins in late February will be $1.3 billion — slightly higher than originally planned, he noted, but identical to the amount Supervalu expects to spend this year. Spending plans for next year will encompass 165 major remodels and the opening of 15 conventional-sized supermarkets and 55-65 limited-assortment stores, including licensed stores, compared with 125 remodels this year (including 85 that have been completed) and 18 new stores.

In other comments to analysts, Noddle said he expects Supervalu to continue to gain leverage from its increased size. “Over the last few quarters we have really just started to study leveraging our national size with scale, and I would expect that will have an increasing impact as we go forward.”