ANALYSTS EYE LONG-TERM PERFORMANCE AT SUPERVALU

ELLIOT ZWIEBACH

MINNEAPOLIS - Wall Street analysts said they are generally upbeat about the prospects for sales gains in the expanded retail division of Supervalu here, despite negative investor reaction to the company's retail sales outlook that pushed the stock to a new 52-week low late last month.

Supervalu stock fell to $26.75 per share on July 28 - from the $30-plus range at which it had been trading since the acquisition of Albertsons in June - and pretty much stayed down last week.

Investor reaction came in the wake of the release by Supervalu of financial results for the first quarter that ended June 17, which showed overall retail sales, excluding Albertsons, dropping 1.8%, with the expectation that overall comps for the year will be flat - up less than 1% at Albertsons and negative at other existing retail properties - compared with anticipated gains of 3%-5% at Kroger and Safeway.

Analysts contacted by SN last week were in agreement that the long-term prospects appear positive, with one exception, who expressed concerns with Supervalu's core retail business.

Mark Husson, New York-based managing director and global head of consumer research for HSBC Securities, London, said the pre-Albertsons retail operations "are not in very attractive markets and they do not sell gasoline, which puts them at a competitive disadvantage, and putting Albertsons into the hands of people who may not have such good hands may not be such a good idea.

"We are concerned enough that we decided to take a couple of investors to meet with the company [last week] so they could meet the new heads of the retail businesses."

As for the outlook for Supervalu stock, Husson said, "Over the next year it will be either one of the best or one of the worst stocks in this space, but it's unlikely to be in the middle."

Other analysts were more upbeat in their thinking about Supervalu's prospects.

"A lot of people are skeptical about the near term, but I don't see any indication that suggests Supervalu is off track with regard to its long-term objectives for Albertsons or its legacy retail business," Jason Whitmer, senior research analyst with Cleveland Research Co., Cleveland, told SN.

"Supervalu is doing a fine job running the business for today and integrating Albertsons for the future, and I'm confident management will do what it has set out to do, though most investors don't think the same way."

Gary Giblen, senior vice president and director of research at Brean Murray, Carret & Co., New York, said he believes the drop in the stock price was an overreaction by some investors. "People are impatient," he told SN. "The history of mega-merger integration in the food industry is poor, and investors are focusing on the risks and anticipating a long period before any benefits materialize.

"There's also a concern that Save-A-Lot may be reaching a plateau and that sales at those stores may soften as low-income customers shop less often because of high gas prices."

But Supervalu executives may also be causing some of the concern by taking too conservative an approach to the integration, Giblen added. "Some companies lay out detailed plans for a post-merger environment and investors usually react positively to that, even if those plans don't always materialize, whereas Supervalu management is saying there's a lot of work to be done and it will take time, with few specifics, and the company is being penalized for that approach."

Short-Term Challenges

John Heinbockel, an analyst with Goldman Sachs, New York, said he was not surprised by the market's reaction. "Investors with a long-term time horizon will be more comfortable [with the results], while for those with a short-term horizon, Supervalu will continue to be challenging. As a company with 75% of its business in retail, how that part of the business performs will weigh more heavily, so the reaction is bound to be more negative. And because this is more of a 2007 story, the shares will likely do little until the fall, at the earliest.

"Kroger and Safeway have set a tough benchmark for everyone in the industry, so the negative comp was perceived to be weaker than it would have been a year or two ago. Going forward, investors will look for sequential improvements in the comp and in integration costs vs. merger synergies. Supervalu can control the latter, but it will be tough to control the sales number."

Perry Caicco, an analyst with CIBC World Markets, Toronto, also has a more positive outlook, laying the blame for slow sales development at Albertsons with that chain's former management. "The core problem at Albertsons [prior to its acquisition] was a terrible customer experience laid on top of great real estate," he said, "[and] we consider this an excellent starting point for change.

"The issue and question facing investors is whether Supervalu can slowly repair and improve the Albertsons assets, and nothing from this [first] quarter suggests they can't. Indeed, Supervalu is seeing slightly positive comps from the acquired stores, which is not surprising, considering how bad those operations were performing during their long operational decline."

Caicco said he is not alarmed "by the apparent sales malaise in parts of the old Supervalu retail business - that's the nature of small isolated regional operations facing competitive openings. Our assumption is that the core assets will produce relatively flat results over time, which is the reason Supervalu stepped up to the table and bought Albertsons."

Caicco also noted that Supervalu plans to deploy $800 million of its $1 billion capital program "against the aged Albertsons assets, [with] those dollars allocated almost entirely to the in-store experience, which was the key failing at Albertsons." Among the focuses of Supervalu's efforts, he added, will be improved fresh assortments, better customer services and expanded drug and HBC assortments.

"[Supervalu] said many price adjustments were being made, in all directions," Caicco added. "In our forecasts we have assumed a substantial investment in pricing at Albertsons, which we believe was the highest-priced player in most of its markets, particularly in the last few months."

One concern Caicco shares with some investors is Supervalu's historic reliance on allowing local managements to run the retail operations. "If there is a weakness in the new company, it may be not just the depth and quality of local management but also the dependence of the corporation on that local depth and quality. For this new larger company to be successful, Supervalu's head office must be a little more involved in regional decisions and directions than they were previously.

"It's very early, but we believe Supervalu's head office is taking a much more active role than previously."

While Supervalu attributed the 1.8% drops in comp sales in its existing retail markets to intense competition in Cincinnati and Fort Wayne, Ind., which represent 4% and 2%, respectively, of its core retail sales, Steve Chick, an analyst with JP Morgan, New York, said in a research report that he thinks the company's retail pressures are more broad-based. However, he could not be reached to elaborate.

Jeff Noddle, chairman, president and chief executive officer of Supervalu, said during a conference call with analysts - before the drop in the stock price - that Supervalu had owned Albertsons for only eight weeks at that point, "but the sales results in [those] acquired properties are better than what they were prior to the acquisition."