Supervalu’s Unsuper Future
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\"SuperValuIn its most recent fiscal year it scored $36.1 in sales volume, driven by a widely diverse portfolio of assets. Those assets include a large-scale wholesale business plus many retail stores ranging from small chains of to large-scale retail chains and a hard-discount chain. In all, Supervalu has more than 2,400 stores.

Supervalu’s asset diversity evolved, for the most part, over a period of cautious and self-financed growth spanning its 135-year history. The company is based in Minneapolis, but operates from distribution centers in nearly 30 states, effectively blanketing much of the nation.

But there are big problems under the surface. When Supervalu is brought into sharp focus, it starts to look troubling. Clarity reveals it to be currently heavily laden with unaccustomed debt and its profitability long sinking and now vanishing.

It gets worse. Its competitive positioning is melting away and its corporate-management team is in fast-turn mode. Supervalu stock is trading near the $2-mark, except for an occasional upward spike driven by buyout rumors. Earlier this year, its stock sold for about $8; five years ago it approached $45. So What’s an Iconic Brand to Do?

In response to its mounting challenges, Supervalu has turned to a capital-conservation mode. It has gone through wave after wave of layoffs, many at the corporate level, others at the store level. At mid year, in response to a quarterly report too disastrous to sugar-coat, the board fired Chief Executive Craig Herkert, who had joined Supervalu in 2009 from Walmart. Wayne Sales, board chairman, was appointed his successor. The board discontinued the quarterly dividend after 60 years of unbroken payment.

Most dramatically, the board also announced it was open to selling all or parts of Supervalu and that it had engaged Goldman Sachs and Greenhill & Co. to help beat the bushes to flush out buyers.

The Back Story

How did Supervalu reach such a state of disrepair and what, if anything, can be done to salvage the situation? And what will happen if no buyer for any of it can be found? Let’s start at the beginning to see if much of what appears to be Supervalu’s strength is actually the core of its weakness.

Supervalu is fundamentally a voluntary grocery wholesaler. Voluntary wholesalers seek to operate at a profit, although there are also non-profit cooperative wholesalers owned by groups of retailers. The co-op model has many weaknesses and their numbers are dwindling.

Wholesalers—voluntary or co-op—acquire product from a myriad of manufacturers, aggregate it in vast distribution centers and then compile truckloads of disparate product to be dispatched to independent retailers’ supermarkets. Many of the independents are one-off operators of a single supermarket, typically under a franchised banner such as IGA or the owning-family\’s name. Many independents operate in rural areas or smaller country towns. An independent-store owner with as many as five or 10 stores would be considered sizable.

That distribution method stands in contrast to those of large-scale chains, such as Kroger or Safeway, which operate their own product-acquisition and distribution apparatus. This almost guarantees that large-scale retailers can offer lower price points since distribution is operated as a break-even enterprise. Wholesalers must up- charge supplied retailers several percentage points to generate their own profitability.

During the course of its history, Supervalu acquired several retailer banners, and so gradually edged into the retail business itself.

Wholesalers, such as Supervalu, generally enter corporately owned retailing because of perverse incentives: A store or chain the wholesaler supplies decides to sell, or it files for bankruptcy. To prevent the loss of the sales volume the distressed retailer represents to the wholesaler, the wholesaler buys it. The same may happen if a retailer threatens to take its business to a competing wholesaler.

In sum, wholesalers such as Supervalu may end up with an unintended portfolio of retail stores, only some of which can be buffed up to resell or even lead back to profitability. Supervalu’s corporately owned roster of smaller retailers include Shoppers, Farm Fresh and Hornbacher’s.

In addition to the business negatives wholesalers run into by owning retailers, they also may project negative optics: incumbent retailers long supplied by the wholesaler may find themselves in the paradoxical situation of being in competition with retailers owned by their wholesaler. When that happens, supplied retailers may start to question the wisdom of doing business with the very wholesaler who is also their retailer competitor.

The Great Leap Forward

But not all retail acquisitions go sour. One of the better acquisitions Supervalu made occurred in 1994 with its buyout of Save-A-Lot. Over the years, this chain of limited-assortment, hard discount stores represented one of Supervalu’s best growth opportunities. Supervalu’s slow creep into retailing was abruptly reversed in 2006 when it took a huge leap into retailing by acquiring the majority of the retail assets of Albertsons for $12 billion in a deal led by Cerberus Capital Management.

The deal was one of the most complex ever undertaken—then or now—because it involved a buyout and two simultaneous flips. In one move, some 700 freestanding Albertsons-owned Sav-On and Osco drugstores went to CVS; and in another move, about 660 Albertsons supermarkets were flipped to a new entity known as Albertsons LLC.

The latter arrangement set up the curious situation of creating two Albertsons chains; one owned by Supervalu, the other owned by Cerberus. And the inside story was that the real task of Albertsons LLC was to dispose of what were the dogs of the other Albertsons. Today, only 200 of them still remain and are actively operated under the Albertsons banner.

The multiple transactions left Supervalu with what was considered to be the most viable assets of Albertsons in the form of about 1,100 supermarkets under multiple banners of Albertsons’ earlier spate of acquisitions including Jewel-Osco, Shaws and numerous others. The deal also larded Supervalu’s books with unaccustomed debt that it had to learn how to manage

At first, the deal looked stellar for Supervalu. After all, the economy was doing well in 2006, which made the new debt load seem less consequential. The acquisition catapulted Supervalu’s annual sales to about $44 billion, on a pro forma basis, or about twice what they had been the previous year. That propelled Supervalu to the position of the nation’s third-largest food purveyor, trailing only Walmart and Kroger.

The deal also converted Supervalu to a predominantly retailing company. Ten years ago, Supervalu drove 47% of its sales volume from wholesaling. Now less than a quarter of its volume comes from wholesaling.

In analyzing Supervalu’s huge buyout move, it’s important to remember that prior to the Great Recession of 2008, a whole range of companies were being encouraged to take on debt in a bid to quickly beef up their value to investors and shareholders. In fact, it became fashionable to go into debt.

Trouble in Paradise

The euphoria about Supervalu’s deal died down quickly. Through no fault of Supervalu’s, the economy took a nosedive. Shoppers refocused on finding low prices. This didn’t play to Supervalu’s strength; it hadn’t been a low-cost provider to its independent customers or its corporately owned units for years.

I attended a trade association seminar more than a dozen years ago at which a Supervalu executive spoke candidly, bemoaning the fact that Supervalu was delivering “insult pricing” to its consumers. He meant that Supervalu’s retail price points were so far above prevailing market prices that shoppers actually felt insulted.

Supervalu also faced headwinds integrating its new stores into its operations. Albertsons itself had made recent acquisitions that went to Supervalu. They were far from integrated into the Albertsons systems. This only exacerbated Supervalu’s difficulties with aligning its new stores with its own systems and methods. Moreover, many of Supervalu’s newly acquired stores had been neglected and were in dire need of renovation.

In short, at the very time Supervalu needed to do a lot of capital spending on facilities and to lower price points, it was hamstrung by newly assumed debt and couldn’t do so.

Waves of Change

When Herkert was imported from Walmart to become CEO in 2009, his mandate was to find a way to turn around Supervalu. Unfortunately, Herkert’s vision—or lack of it—was to find ways to delay the day of reckoning with the hope that the recession would lift quickly enough to salvage the situation before it got even more ugly. Specifically, he made moves to trim costs, lower price points in specific categories, and make minor tweaks to stores to enhance the shopping experience.

Another key element of his strategy, though, seemed more promising. That was to pump up the Save-A-Lot discount chain, the only part of the company showing much life. He aimed to double the size of the chain to about 2,400 stores in five years.

Herkert’s strategy was simply too little and too late.

Quarter after quarter went by, and sales and profits dwindled, Herkert continued to insist that his plan would take hold given more time. He did speed things up by closing numerous underperforming stores, selling some distribution assets and weeding the company of many workers, some at store level and hundreds from its headquarters staff. Ironically, Herkert rid the company of the same executives he had brought aboard earlier in his tenure.

And so it went until this July when Supervalu reported its first-quarter results. It became obvious then to even the most optimistic that Supervalu had reached a tipping point and that it was almost certainly unsalvageable in its current form. There was an alarming drop in same-store sales by 3.7%, a revenue decline of 4.7% and a profit drop of 45%.

Not long after the quarterly report was issued, Herkert was out and other drastic actions aimed at slowing the downward tumble were implemented. Of course, the biggest action of all was to make it known that the entire company, and any of its parts, were for sale.

Wayne Sales, the incoming CEO, halted virtually every element of Herkert’s plan, including the price initiatives, the rollout of Save-A-Lot units and most capital spending. He also announced the closure—not even the sale—of 60 stores, including 22 Save-A-Lots. The new plan seems to be to hanging on long enough for a buyer to emerge.

Back to the Future

Some trade observers say that very few of Supervalu’s assets will attract a buyer. The most optimistic prediction is that parts of Supervalu could be sold as ongoing enterprises or simply as real estate.

One possibility is that a buyer for Save-A-Lot could surface, although the fact that 22 of them are about to be shuttered bodes ill. Even more complicated, all but a few hundred of the 1,330 Save-A-Lots are owned by licensees and are not, strictly speaking, Supervalu’s to sell. And then there’s the wholesaling business that could be attractive to the right buyer.

Also it’s fairly certain that even if a buyer for the whole Supervalu enterprise manifests, that buyer would most likely see Supervalu as a company to dismember and parcel out. Another possibility is that Cerberus could acquire Supervalu to sell off its parts, reuniting the two Albertsons chains.

Few are predicting that Supervalu will file for bankruptcy, let alone be driven to liquidate, although there is historical precedent for just that; in 2003 Supervalu’s closest industry peer, Fleming Cos., did shut down abruptly and liquidate. To be sure, Fleming faced a different set of challenges than does Supervalu.

Since the dark days of the summer of 2012, Supervalu’s fortunes have skidded further. Its second-quarter results, issued in October, featured a loss of $111 million, including expenses related to downsizing.

Let’s hope that whatever is next for Supervalu starts to unfold soon. In any event, the Suervalu we’ve long known will never be the same.

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