Why I'm Staying Away From This Stock

Before you go, we thought you'd like these...
Before you go close icon

I've made this joke before and I'll make it again -- SUPERVALU's terrible business and SVU ticker can't help but make me think of the TV show Law & Order: Special Victims Unit. But SUPERVALU shareholders in the last year probably don't feel like the company has committed any especially heinous crimes against them, with the stock handily outperforming peers like Kroger and Safeway . In fact, in its most recent quarter, SUPERVALU managed to increase revenue, gross margin, and total profits. Read on to look a gift horse in the mouth and see why I'm still bearish on this company.

Splitting hairs
Let's start with the bottom line. SUPERVALU reported a second-quarter profit of $40 million, an improvement over last year's $111 million loss. That $40 million gives SUPERVALU a profit margin of 1%, so thin you could split a hair with it.

But if SUPERVALU is on the right track, it should still get some credit for the improvement. After all, the company could double profits just by expanding margin by 1 percentage point. But much of the improvement came from the company's "Transition Services Agreement," or TSA, which accounted for basically all of the improved revenue and margin. The TSA relates to SUPERVALU's sale of several of its major brands, such as Albertson's and Acme, earlier this year. The agreement is essentially what it sounds like, with SUPERVALU collecting a consulting fee for providing certain transition services to the brands' new owners.

This is like the opposite of the dreaded "restructuring costs" companies sometimes incur, where earnings might be depressed for a few quarters while the company experiences an irregular cost such as retail store remodeling, and earnings seem to improve a year later when those costs phase out, even if the core business stayed the same. Here, SUPERVALU seems to have improved sales and profits, when it is simply collecting a temporary fee that is set to phase out in one to five years from the sale date, already nearly a year past.

The bad news
Because of the TSA, Corporate was the one segment that actually had sales improvement. The Independent Business segment, which provides wholesale distribution to independent stores, fell 1.6% , and SUPERVALU's own stores fared little better, with a decrease in sales of 1.1% in the Retail Food segment.

This isn't too surprising, given the increasing divide between upscale grocers and deep-discount stores, leaving mid-range stores like SUPERVALU behind. But Kroger saw a 4.6% increase in sales this quarter, and Safeway saw a 1.1%  increase, so it wasn't all bad for the category as a whole. However, Kroger and Safeway both suffered from decreasing margins, which in Safeway's case led to lower profits. I've been bearish on Safeway as well, but I'd still rather own a store with increasing sales and decreasing profits than one with declining sales and ephemeral profits.

Even SUPERVALU's deep-discount Save-A-Lot brand saw a slight decrease in sales, in a category that just keeps growing. Companies like Dollar Tree and Family Dollar have shown over the last few years that it's almost difficult not to increase sales in the deep-discount space.

Refuting the bulls
SUPERVALU bulls might point to the company's recent management changes and its attempts at lowering its debt burden by selling off assets. It's true that the company has replaced many of its top officers in the last year, but it's also true that SUPERVALU is on its third CEO since 2009, during which time the stock has fallen nearly 60%. Maybe the third time's the charm, but the company hasn't shown a great track record so far.

Meanwhile, SUPERVALU has sold off the bulk of its grocery brands, but what does that leave it with? A lowered debt burden and a business that continues to lose sales and underperform its peers. The problem with selling off large chunks of the business in order to pay off debt is that at some point it gets counterproductive. This is a point I've made about Dean Foods several times. After selling off most of its businesses, Dean is left with nothing but a conventional milk pure play. Milk is a volatile commodity and milk consumption has been trending down for decades. Dean will be hard pressed to turn enough profits to keep paying down its still onerous debt.

The Foolish bottom line
A commenter on my colleague Chad Henage's SUPERVALU article claimed that SUPERVALU is "very cheap play on food distribution. ... A very stable business [with] a nice economic moat." For the reasons Chad and I have cited, I have to disagree that it is a stable business with any sort of moat, and the stock can't be called "cheap." Because it's lost money over the last year, it has no P/E to judge it by. It has no dividend either. Kroger and Safeway both have steadily rising dividends and Kroger has a relatively low P/E to boot. I'm definitely staying away from SUPERVALU.

What's the best approach to investing?
It's actually simpler than you might think: Choose great companies and stick with them for the long term. SUPERVALU doesn't fit that criteria, but The Motley Fool's free report "
3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

The article Why I'm Staying Away From This Stock originally appeared on Fool.com.

Fool contributor Jacob Roche has no position in any stocks mentioned. The Motley Fool owns shares of Dean Foods. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

People are Reading