Supervalu's (SVU) weak second-quarter results underscore the challenges of undertaking accelerated price investments that cause significant near-term deterioration in both identical store (ID) sales and gross margins, according to Fitch Ratings.
We remain skeptical of SVU's ability to sufficiently narrow the price gap with its competitors to drive longer term improvement in ID sales and believe the company may not have the financial wherewithal to sustain the needed investments.
In addition, the profit deterioration in each of SVU's operating segments is likely to constrain asset sale proceeds that result from the company's strategic review. We rate SVU's issuer default rating 'CCC', given our concerns around the company's long-term viability.
SVU reported weak second quarter results Thursday, with significant margin pressure due to price investments in all three of its segments. The retail food segment, which encompasses the company's traditional supermarkets, saw its ID sales drop by 4.3% and its operating margin narrow by 110 basis points.
Having completed the planned price investments in its Chicago-based Jewel banner, management indicated that it will be slowing the pace of price investments while it evaluates the results in Chicago. However, this only serves to push out the investments needed for SVU to attempt to become price competitive. In addition, even with a slower pace of price investments, we expect continued downward pressure on gross margins as discounters grow and other traditional supermarkets continue to invest in their prices. We therefore do not expect any meaningful improvement in ID sales trends.
SVU also experienced continued pressure in its Save-A-Lot "hard discount" retail business and in its independent (wholesale) business in the second quarter. Save-A-Lot's ID sales were down 3.7% and its operating margin narrowed by 165 basis points to 3.5%. This is particularly disappointing, given that hard discount operators typically thrive in this cautious consumer environment as their prices are more competitive than discount retailers such as Walmart.
Sales in the independent business were up 1%, but its operating margin was down by 37 basis points given price investments, which implies the company was unable to pass along cost increases to its customers.
While SVU is in the process of soliciting offers for all or part of its business, weak trends may reduce the level of interest in these businesses and in the multiples investors are willing to pay. We continue to believe that the sale of the business as a whole is highly unlikely, given the very weak core retail business and the unwillingness of market participants to take on these businesses as significant price as well as other investments would be required to turn these operations around.
Based on current trends, we believe SVU's EBITDA could trend down to $1.4 billion to $1.5 billion for fiscal 2013 (ending February), down 18%-23% from $1.8 billion in fiscal 2012. This would imply an increase in adjusted debt/EBITDAR to around 5.0x from 4.2x at fiscal year-end 2012, assuming $400 million in debt reduction.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
Brian Bertsch, +1-212-908-0549
Media Relations, New York
Philip M. Zahn, CFA, +1-312-606-2336
70 W. Madison Street
Chicago, IL 60602
Monica Aggarwal, CFA, +1-212-908-0282
Senior Director, +1-212-908-9123