SUPERVALU: Dividend Dynamo or the Next Blowup?

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Dividend investing is a tried-and-true strategy for generating strong, steady returns in economies both good and bad. But as corporate America's slew of dividend cuts and suspensions over the past few years has demonstrated, it's not enough simply to buy a high yield. You also need to make sure those payouts are sustainable.

Let's examine how SUPERVALU (NYS: SVU) stacks up. In this series, we consider four critical factors investors should examine in every dividend stock. We'll then tie it all together to look at whether SUPERVALU is a dividend dynamo or a disaster in the making.

1. Yield
First and foremost, dividend investors like a large forward yield. But if a yield gets too high, it may reflect investors' doubts about the payout's sustainability. If investors had confidence in the stock, they'd be buying it, driving up the share price and shrinking the yield.

SUPERVALU yields a whopping 5%, considerably higher than the S&P 500's 2.1%.

2. Payout ratio
The payout ratio might be the most important metric for judging dividend sustainability. It compares the amount of money a company paid out in dividends last year to the earnings it generated. A ratio that's too high -- say, greater than 80% of earnings -- indicates that the company may be stretching to make payouts it can't afford, even when its dividend yield doesn't seem particularly high.

SUPERVALU doesn't have a payout ratio because it didn't generate net income over the past twelve months. However, on a free cash flow basis its payout ratio is a modest 16%.

3. Balance sheet
The best dividend payers have the financial fortitude to fund growth and respond to whatever the economy and competitors throw at them. The interest coverage ratio indicates whether a company is having trouble meeting its interest payments -- any ratio less than five is a warning sign. Meanwhile, the debt-to-equity ratio is a good measure of a company's total debt burden.

Let's see how SUPERVALU stacks up next to its competitors:

SUPERVALU926%2 times
Whole Foods1%144 times
Kroger157%5 times
Safeway110%4 times

Source: S&P Capital IQ.

Grocery stores tend to be stable yet somewhat capital-intensive -- hence the high debt-to-equity ratios and low interest coverage rates for SUPERVALU, Kroger, and Safeway. SUPERVALU in particular has its work cut out as it tries to make headway deleveraging itself. Whole Foods' return on assets -- 8.4% -- is significantly higher than its peers', so the company has been able to quickly pay off its debt over the past few years.

4. Growth
A large dividend is nice; a large growing dividend is even better. To support a growing dividend, we also want to see earnings growth.

SUPERVALUN/A*(12%)
Whole Foods7%(8%)
Kroger7%17%
Safeway(2%)20%

Source: S&P Capital IQ. *Negative net income.

While Whole Foods and Kroger have managed to grow their earnings over the past several years despite the economic downturn, SUPERVALU and Safeway have struggled to maintain profitability. Both have engaged in capital spending to try to turn things around.

The Foolish bottom line
Despite its high dividend yield and cheap valuation, SUPERVALU can't really be considered a dividend dynamo. Although a significant dividend cut may not be necessary due to its low free cash flow payout ratio, SUPERVALU still has some work to do deleveraging and hanging on to its revenue and earnings. However, if you're looking for some great dividend stocks, I suggest you check out "Secure Your Future With 11 Rock-Solid Dividend Stocks," a special report from The Motley Fool about some serious dividend dynamos. I invite you to grab a free copy to discover everything you need to know about these 11 generous dividend payers -- simply click here.

At the time this article was published Ilan Moscovitzowns shares of SUPERVALU and Whole Foods Market.The Motley Fool owns shares of SUPERVALU and Whole Foods Market.Motley Fool newsletter serviceshave recommended buying shares of Whole Foods Market.Motley Fool newsletter serviceshave recommended buying calls in SUPERVALU. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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