Supervalu, 9% Yield-to-Maturity, Maturing November 2022
This week, our bond review highlights one of the largest grocery wholesalers and retailers in the United States. Supervalu has had several positive developments over the past 6 months which is making the company more competitive.
The company recently posted an excellent net sales increase in Q1 of 6.3%, with an increase of 12.4% in wholesale net sales.
Supervalu completed its acquisition of Unified Grocers in June 2017, which is projected to add $35 million in adjusted EBITDA this fiscal year.
In its last fiscal year, the company sold off its Save-A-Lot stores, which allowed the pay-down of its outstanding debt by $1.1 billion, thereby reducing annual interest expense as well.
Supervalu has had several recent wins in its distribution business which contributed to its latest quarterly wins. Moving forward, the Unified acquisition should provide a welcomed boost to net sales and profits. The company’s 2022 bonds with a current yield-to-maturity of about 9% provide excellent diversification into the retail grocery space and will make a sound addition to our Fixed-Income2 managed portfolio, the Q3 2017 aggregate performance of which is shown below.
Latest Quarterly Results
Supervalu posted its results from its fiscal 2018 first quarter (sixteen weeks ended June 17, 2017). These results show the improvements from the company’s recent acquisition as well as new customers in its wholesale /distribution business.
Q1 net sales increased by 6.3% over last year ($4.00 billion compared to $377 billion).
Q1 wholesale net sales increased by 12.4% year-over-year ($2.56 billion compared to $2.28 billion).
Interest expense in Q1 was $43 million, a decrease $53 million a year ago. This was due to Supervalu’s sale of its Save-A-Lot store division, and the resulting proceeds used to de-lever its balance sheet by $1.1 billion in Q4 last fiscal year.
Supervalu continues to grow its wholesale segment, which now comprises 63% of total net sales, versus 60.4% of net sales for the same period last year.
Supervalu added distribution business to around 160 Fresh Market stores during the quarter, and also added business distributing to America’s Food Basket and Marsh Supermarkets. The company has also acquired new customers from Central Grocers’ recent bankruptcy filing.
About the Issuer
Supervalu is the largest public company grocery distributor to wholesale customers across the United States through its wholesale segment, operates five retail grocery banners in six geographic regions through its Retail segment and provides professional service solutions to retail operators and other entities, the results of which are included within wholesale or
corporate depending on the customer type. Supervalu leverages its distribution operations by providing wholesale distribution and logistics service solutions to wholesale customers as well as wholesale distribution to Supervalu’s retail stores. Supervalu Inc. was organized in 1925 as the successor to two wholesale grocery firms established in the 1870s.
Supervalu’s business is classified by management into two reportable segments: wholesale and retail. These reportable segments are two distinct businesses. The wholesale reportable segment derives revenues from wholesale distribution of groceries and other products, logistics services and professional service solutions to retail stores and other customers (collectively referred to as “wholesale customers”). The retail reportable segment derives revenues from the sale of groceries and other products at retail locations operated by Supervalu. Substantially all of Supervalu’s operations are domestic.
Acquisition of Unified Grocers
On June 23, 2017, Supervalu completed the acquisition of Commerce, CA based Unified Grocers. Founded in 1922, Unified Grocers is a wholesale grocery distributor that supplies independent retailers throughout the western United States. This acquisition provides Supervalu with additional growth opportunities across various geographical areas including the western United States as well as increasing its business in specialty, gourmet and natural / organic products. Other highlights of this acquisition include:
The combined company is projected to have total sales around $16 billion (based on last year’s sales figures).
With this acquisition, Supervalu’s wholesale operations will likely represent more than 70% of total net sales.
Supervalu management estimates Unified’s contribution to adjusted EBITDA in the current year to be approximately $35 million.
Supervalu estimates operating synergies of around $60 million by the end of the third year.
Supervalu’s excellent Q1 results did not include any results from the Unified acquisition. That being said, Q2 results should reflect increases in net sales and adjusted EBITDA.
The way we buy groceries continues to evolve. Here are a few trends currently shaping in the grocery retail space:
Offline and online converge: While the adoption of online grocery shopping has not reached the level of apparel and home goods, adoption is increasing, mainly with younger shoppers. Many shoppers still prefer to personally shop for fresh goods – meat and produce. But, moving forward, more shoppers will start moving the mundane task of shopping for regularly replenished goods — beverages, paper products, packaged nonperishable food and other household basics — online.
More marketing budget aimed at social media: Social media allows brands and retailers to be where their customers are, developing brand advocates in the general public.
Shopping experience tops price: The addition of coffee bars, wine tasting areas and catering services are ways grocery retailers seek to differentiate themselves from the competition. Plus, if the customer stays in the store longer, the chance of adding to their total purchase increases.
Obviously, Amazon’s recent acquisition of Whole Foods has made the entire grocery industry take notice and has been cause for concern. However, the public’s increasing preference for fresh foods will continue to favor consumers personally shopping, at a traditional brick-and-mortar store, for at least a portion of their weekly groceries.
Interest Coverage and Liquidity
Interest coverage is of paramount importance for bondholders as it indicates a company’s ability to service its existing debt. For its latest quarter, Supervalu recorded operating income of $67 million and interest expense of $43 million, resulting in an interest coverage ratio of 1.6x.
If adding back non-cash depreciation and amortization expense of $60 million, this raises operating income to $127 million, which would bring interest coverage to nearly 3x.
In terms of cash reserves, Supervalu showed a healthy level of cash on hand at the end of its last fiscal quarter of $252 million.
The risk to bondholders lies in whether Supervalu can continue to capitalize on its return to its core business of grocery wholesale / distribution. The company made a wise decision to acquire Unified Grocers, which give them entry into many markets on the west coast. In addition, the company has picked up business from the recent bankruptcy of another distributor (Central Grocers). Mark Gross, Supervalu’s CEO, also indicated there are additional opportunities for the company to expand, “I see significant further opportunities for us to grow that business and for us to be a consolidator. Wholesale, more and more, becomes the dominant part of everything we do”. While the grocery space is undergoing significant change right now, Supervalu is taking advantage of its strong distribution framework, advancing as it determines what will best benefit the company moving forward. In light of these considerations, the current yield to maturity of about 9% on the company’s 2022 bonds outweighs the risks identified.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
Supervalu, while not a readily recognized name in the grocery space, is one of the top grocery wholesalers and retailers in the United States. Its recent acquisition of Unified Grocers will be immediately accretive, with management estimating an increase of $35 million in adjusted EBITDA this fiscal year. This and other recent wins in its distribution business should provide a healthy increase in net sales this year and moving forward. Supervalu also has the opportunity to increase its reach further through additional acquisitions of smaller, regional distributors. The company’s 2022 bonds, with a competitive yield-to-maturity of about 9%, are an excellent addition to a diversified income portfolio, and as such, we are targeting these bonds for addition to our FX2 managed income portfolio, the benchmarked and aggregated third quarter 2017 performance of which is shown above.
Issuer: SuperValu, Inc.
Bond Coupon: 7.750%
Yield to Maturity: ~9.04%
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Disclosure: Durig Capital and certain clients may have positions in Supervalu 2022 bonds.
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