Just because company “A” acquires company “B” doesn’t imply that company “A” will have a bright future. Additionally if “B” is performing miserably, “A” should look to sell in order to unlock the remaining enterprise value. This frees up capital for “A” and eventually reduces the drag on its earnings. Such is the case with SUPERVALU INC. (NYSE:SVU), and here are a few reasons why it makes a great investment option.
A Blessing in Disguise
Supervalu recently announced that it would be selling five of its retail chains to Cerberus for $3.3 billion. As per the deal, SUPERVALU INC. (NYSE:SVU) will sell 877 stores for $100 million in cash payment, and the remaining $3.2 billion would be assumed as Cerberus’ debt. Moreover, Cerberus would be required to bid for up to 30% stake in Supervalu, at $4 a share and the deal is expected to close in March. Supervalu had purchased Alberton's for around $12 billion back in 2006, and over the last 7 years it seems to have destroyed more than 70% of its valuation. However this deal will not merely salvage its remaining value, but would also free up cash flows that its 877 stores are currently guzzling up.
According to Ycharts, its total liabilities stand at a towering $11.85 billion, and post deal it should shrink to $8.65 billion. This has two benefits. Its interest expenses will shrink massively and the company would have to mainly worry about its long term debt (around $6 billion). Furthermore, with a 30% debt reduction, lenders would be willing to restructure their loans, which not only reduces annual interest burden but also delays the repayment period (ofcourse these are the possibilities and not facts).
Corroborating a Value Play
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At the first glance, it’s not hard to conclude that Supervalu is the laggard amongst the mentioned peers. The Kroger Co. (NYSE:KR) and Safeway Inc. (NYSE:SWY) still appear to be undervalued, with high gross margins. Their shares have also performed exceedingly well over the last 6 months, and they appear to be solid growth picks. However Whole Foods and Costco appear to be fairly valued and initiating longs at the CMP would entail comparatively greater risk.
But on taking a critical look, Supervalu appears to be a value play here. Its net margin may be the worst amongst the suggested group, but its gross margin is higher than the industry average. The company is able to generate healthy gross earnings, but is not able to filter them out as net earnings due to higher operating costs and high interest expenses ($126 million). This calls for business restructuring and that’s what Supervalu is doing here.