Grocery Stocks: Don’t Be Fooled

Traditional grocers are leading organic ones, but it won't last

   

Something strange is going on in the grocery aisles these days: Names like Safeway (NYSE:SWY) and Supervalu (NYSE:SVU) — which seemed left for dead — have come to life and lead all grocery stores in terms of performance over the past three months.

Meanwhile, stars like Whole Foods (NASDAQ:WFM) and The Fresh Market (NASDAQ:TFM) are stuck in reverse.

What’s behind this bizarre turn of events? Let’s take a look.

SuperValu

Supervalu is up over 50% in the past three months and 56% year-to-date. If it can hang onto enough of these gains through the remainder of the year, it will have its first positive year since 2007 … but that’s a big “if.” Much of these gains have come as a result of the company’s restructuring plans, which are currently underway.

The most important part of this restructuring is the sale of its Albertsons, Acme, Jewel-Osco and Shaw’s stores to a private equity firm Cerberus Capital Management and a consortium of real estate firms which include Kimco Realty (NYSE:KIM). The group is paying $100 million plus the assumption of $3.2 billion in debt for the 877 stores.

Cerberus is also buying 30% of Supervalu’s stock for $4 a share in a tender offer set to expire Feb. 25. Its stock closed trading Jan. 9 at $3.04, the day before the transactions were announced. Obviously, it’s now trading closer to $4 thanks in large part to the tender offer. However, LBO speculation beginning in October is what brought it from below $2 in mid-October to $3.04 the day before the announcement.

The real question, though, is what comes next. While the sale reduces its total debt by half, it doesn’t solve Supervalu’s main problem of being terrible at retailing; the company’s roots lie in wholesaling. And as industry expert Ron Pelger states in an article about its new direction in The Produce News: “Supervalu … needs to get back to doing what they do best.”

Still, the newest plans call for SuperValu it to focus on its discount Save-A-Lot chain, wholesale distribution to independent grocers and its regional store brands including Cub Foods and Farm Fresh. Focusing on three businesses is a recipe for disaster.

Until it commits to one of them, the gains its stock has made in the past three months will be all investors should expect. Also keep in mind that Supervalu’s independent business segment in the first nine months of the year through Dec. 1 saw earnings decline by 18% year-over-year on flat revenue. It needs better margins … and needs them fast.

This company is dead money until newly appointed CEO Sam Duncan can demonstrate its plan goes beyond selling assets like Albertsons, which it paid a king’s ransom for.

Safeway

What about Safeway? Well, I had high hopes for the company, especially because of its Blackhawk Network gift-card business. Still, the stock has lost one-third of its value in the past five years … including its double-digit bump year-to-date.

Apparently, the gift-card business is still going strong, as Safeway is contemplating spinning off part of its 49% interest, which could bring the grocer as much as $200 million from an IPO. It’s about three years too late, though. Sure, the gift-card operator is still growing revenues by double digits annually, but the real question is what it would do with that extra cash.

Also driving the stock price at the moment is the rumored sale of Safeway’s Canadian stores, which had operating income of $389 million on $6.7 billion in revenue compared to $746 million in operating income on $36.9 billion in revenue from U.S. stores. Heck, the Canadian business generated 35% of Safeway’s operating profit on 15% of the revenues. It’s a veritable cash cow in comparison to the stores in the states.

It’s for this reason that both Canadian grocery chains Metro (PINK:MTRAF) and Loblaw (PINK:LBLCF) are rumored to be interested in Safeway’s Canadian connection. Again, though, Safeway management doesn’t seem to have a plan for the proceeds, expect to maybe buy back more shares. That hasn’t stopped investors from pushing its stock up since the beginning of the year, but it won’t be enough to help resuscitate the business.

The Bottom Line

At the end of the day, soaring stocks aside, the same companies remain ahead of the pack.

Sure, Whole Foods and The Fresh Market are each facing extremely competitive market forces, making any kind of margin expansion next to impossible and meaning same-store sales growth is expected to slow somewhat over the next year. That reality has affected both stock prices, but the future for both companies is more than alright.

Whole Foods and The Fresh Market are each expanding across the country, so a few bumps in the road are to be expected. You also have to remember that Whole Foods’ stock has been on an almost straight line up since November 2008. It had to take a breather at some point. In three years from now, I bet you’ll be looking backwards at a chart that looks eerily similar to one for the past three years.

All in all, companies (like Whole Foods) with strong operations will continue to win. Those operating poorly with no direction in sight (like Supervalu) will continue to lose. Despite the recent stock trends, little has changed.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities. 


Article printed from InvestorPlace Media, http://investorplace.com/2013/02/grocery-stocks-dont-be-fooled/.

©2014 InvestorPlace Media, LLC

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