Catching a falling knife...SVU

SuperValu, SVU has been probably the worst performing stock in my portfolio over the past 12 months. Dividends have made up for it (a little bit) but not much. As SVU has decreased slowly over the past 6 months, two earnings reports have come out. Given this extra information, I find myself evaluating further as it has reached my target where I planned to buy more. (I tend to purchase stocks in 3 lots see my BTU post here) If I am catching a falling knife, at least it is a smaller performance hit short term.

My main thesis is that Sav-A-Lot will be a catalyst (spinoff/separation of the company) to increase value. I would not be surprised if the company starts reporting the business as separate units. In the last conference call, management talked about Sav-A-Lot with positive 3.2% identical store sales. The store base at fiscal year end was 1332 stores; of which 397 are owned while 935 are independently operated. In addition, next year the plans are to open 50 new stores (or 3.8%) . These stores average about 15,000 square feet.

When comparing Sav-A-Lot to other lower priced stores like dollar stores, you can use those metrics to value the business. When I looked at Family Dollar Stores (FDO, of which I am also long) the metrics were similar. FDO SSS increased by 3.7% (vs 3.2%) while they expect to increase new stores by about 6-7% (vs 3.8%). Using FDO valuation (which I think is undervalued) you can value Sav-A-Lot at 2.8B.

SVU equity value is only 1.2B but the Enterprise Value is over 8B with debt. While I think Sav-A-Lot will be a catalyst, just based on Sav-A-Lot, SVU is not a buy.

The second way I looked at SVU was doing a valuation based on the EBITDA to Debt valuation. Based on competitors SWY (1.96 ratio) and KR (1.85 ratio) I ran some scenarios based on how long it would take to get there. Unfortunately, it takes quite some time (10+ years) using (what I think) conservative assumptions.

I said that EBITDA and debt repayment would both shrink by 5% per year, even with management closing underperforming stores, spending money on renovating existing stores, and spending growth CapEx on Sav-A-Lot (which will become a larger part of the business over time). In the past year, management has been able to stem the decline in identical store sales from 6.0% to 2.8%. This has been done by taking costs out of the business and reinvesting into lower price points (closing the gap with competitors). I think it is reasonable to think sales might actually increase (nominal with the help of inflation) in 2-3 years.

Once SVU were to get to a 2.00 EBITDA to Debt ratio, going forward mgmt would target a 5% yield payout and that 50% of the outflows would be geared at that ratio. Using those numbers, I calculate an annual return of 7.5% to 11%. At those returns, I am willing to wait while looking (hoping) for a potential catalyst in the next 1-3 years of either Sav-A-Lot unlocking of value or identical store sales turning positive.

At the same time, 7.5% to 11% does not really meet my investing criteria for a larger position in my portfolio. I target 15%-20% returns as I know that I need some larger winners to offset smaller losses. I decided to remove my outright limit order below the market and instead sell 5 puts (cash covered) for 0.35-0.40 Monday morning. Long SVU, FDO at the time of writing. No position in KR or SWY