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Leaders upbeat as analysts fret over debt levels

BY Jim Frederick

Supervalu now has four quarters of operation as a combined company under its belt since its high-profile purchase of 1,124 supermarkets and food/drug combo stores from Albertsons in June 2006. And the track record Supervalu has notched thus far seems to justify the faith that chairman and chief executive officer Jeff Noddle placed in the merger, which he called a transformative transaction.

For the first quarter of fiscal 2008, ended June 16, 2007, Supervalu reported record sales of $13.3 billion compared with $5.8 billion in the first quarter of fiscal 2007, record net earnings of $148 million compared with $87 million last year and diluted earnings per share of $0.69 compared with $0.57 last year, a 21 percent increase.

“On all fronts, this was a highly successful first year, which sets the foundation for the next two years of our journey following the acquisition,” Noddle said in the company’s earnings release. “The double-digit increase in our first-quarter earnings completes a full year of double-digit accretive results. We are now beginning to execute our business plans that will maximize the full potential of our transformed company, including the delivery of synergies.”

Nevertheless, Supervalu’s pre-acquisition “legacy” stores remain plagued by low same-store results. In a July 24 conference call with Wall Street analysts, Noddle acknowledged the impact of competition and other factors, but expressed confidence in the long-term outlook.

Supervalu’s sales and earnings: What a difference a year makes.

Net sales (in millions)Operating earnings (in millions)Source: Supervalu
  First quarter ended 6/16/07 First quarter ended 6/17/06
  Retail food and drug $10,423 $2,930
  Supply-chain services 2,869 2,953
  Total net sales 13,292 5,783
  Retail food and drug $449 $128
  Supply-chain services 67 76
  General corporate expenses 50 36
  Total operating earnings 466 168
Net earnings after taxes, interest $148 $87

“Our identical-store sales on a combined basis increased 1.2 percent in the quarter, with the acquired properties at 1.7 percent and legacy Supervalu at negative 0.4 [percent],” he said. “We attribute this to a combination of factors including: competitive activities in certain markets, the pressured consumer, as well as its inflationary impact to our pharmacy sales related to price reductions for several major generics—another industrywide dynamic that will play out over the next several quarters.”

Nevertheless, Noddle predicts a full-year same-store sales gain of 1 percent to 2 percent companywide.

For most investment analysts who follow the company, the picture is more nuanced. Most remain leery about the high debt levels Supervalu assumed when it bought the crown Jewels of Albertsons’ supermarket operations. Wall Street also seems to hold nagging concerns about the fact that Supervalu took on such a debt-laden, expensive expansion in national reach and store count in a time of unflinching competition, with Wal-Mart relentlessly adding supercenters across the country, warehouse club stores and no-frills discount food stores gaining ground, European discount food retailer Tesco preparing to enter the U.S. market in Texas, and such high-end natural foods brands as Whole Foods rapidly gaining share.

Against this backdrop, most analysts are taking a wait-and-see attitude before they can endorse Supervalu’s new business model completely.

The combination—one of the largest in U.S. supermarket history—cost Supervalu $17.4 billion in cash, stock and roughly $6 billion of assumed debt. In return, the company overnight doubled in size to $44 billion in annual sales and more than 2,450 stores. It also expanded Supervalu’s retail reach to 42 states, absorbed Albertsons’ best-practice expertise in combo-store and pharmacy marketing through such operations as Jewel-Osco and Sav-on, and brought into Supervalu’s empire Albertsons’ stores that were performing at higher operating margin standards than those of Kroger or Safeway, according to investment analysts First Call’s 2006 estimates.

In addition, Noddle told investment analysts in July, “We are well-positioned to leverage our new scale and achieve the $150 million to $175 million of synergies by the end of the third full year anticipated since the acquisition of the Albertsons premier retail properties. Fiscal 2008 is off to a very good start with strong business plans to build upon this first year of success.”

The deal made Supervalu a highly leveraged company, noted Lehman Brothers analyst Meredith Adler soon after the merger was announced. In the initial aftermath of the acquisition, the deal also prompted Fitch Ratings to downgrade Supervalu’s credit rating.

Despite the concern, Lehman, Fitch and other company-watchers found plenty of silver linings in their long-term outlook. Following the release of Supervalu’s fourth-quarter results earlier this year, Adler noted that same-store gains were coming “faster than expected, [thanks to] better in-store operations with a greater focus on customer service, cleanliness and improved employee moral.”

Citigroup retail analyst Deborah Weinswig, for her part, expressed praise for Supervalu’s Premium Fresh & Healthy marketing and store-makeover theme, but impatience with what she characterized, in a Sept. 11 report, as the slow rollout of the format.

Noting that the remodeling initiative would “slowly…improve [the] store base,” Weinswig noted, “We are excited by SVU’s Premium Fresh & Healthy program, which incorporates store remodeling and merchandising efforts focused on fresh perishable products.… However, since November 2006, SVU has launched less than two dozen PFH stores.”

Weinswig also warned that “intensifying competition could pressure margins” at the supermarket giant, at least in the near term. “Supervalu continues to face fierce competition from other non-supermarket food retailers, discounters/supercenters, warehouse clubs, drug stores, dollar stores, convenience stores and restaurants,” the report noted. “The highly competitive retail environment could lead the company to lower prices in order to drive market share, which could have a negative impact on operating margins.”

Specifically, Weinswig reported, “prices at SVU’s newly acquired Albertsons banners, on average, are 24 percent higher than those at WMT [Wal-Mart],” compared with an 8 percent price premium to Wal-Mart at rival Kroger Co.

“With expanding supercenter penetration [by Wal-Mart] and with Tesco’s 4Q07 entry, SVU will likely be pressured to rethink its pricing strategy,” Weinswig noted. She added that “customers are trading down to lower-cost items” as the economy weakens.

Those concerns aside, Weinswig advised Supervalu investors to hold onto the stock to await the unfolding of “the full potential of both its Premium Fresh & Healthy and private-label initiatives” in the face of “strong competition and macro-economic headwinds.”

Joseph Agnese, an analyst with Standard & Poor’s, noted in a July 24 report that Supervalu’s recent earnings picture “benefited from acquisitions and a more favorable retail food environment, despite a significant rise in interest expense and share count.” With Supervalu’s same-store results up only modestly at many of the company’s banners, he too sounds a cautionary note for the short term, but advises that investors hold onto the stock.

Supervalu’s top managers, for their part, remain confident in their strategy for the 2,500-store powerhouse. Noddle predicted the company would be able to generate enough cash flow to pay down about $400 million a year in debt. And, despite the intense competition in supermarket retailing, the high cost of fuel, an expected slowdown in consumer spending and other factors, company leaders laid out a bold, but thoughtful, scenario in the company’s annual report earlier this year.

“We believe we can be successful against this industry backdrop with our regional retail formats that focus on local execution, merchandising and consumer knowledge,” management reported. “In addition, our operations will benefit from our efficient and low-cost supply chain and new economies of scale as we leverage our retail food and supply chain services operations.”

Supervalu’s strategy, the company noted, is “to expand regional retail banner square footage through selective new store growth in key markets where we have significant market share.”

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Fred’s reports both monthly and quarterly record sales

BY Allison Cerra

MEMPHIS, Tenn. Fred’s Inc. reported record sales for the five-week and eight-month periods which ended Oct. 6, 2007.

The company said Friday that its total sales for the month increased 2 percent to $161.4 million compared to the same period last year. Total sales for the year-to-date period increased 5 percent to $1.157 billion.

Same store sales for the month rose 1 percent on top of a 5 percent increase in September last year. On a comparable store basis, sales increased 1.3 percent through the first eight months of fiscal 2007 compared with a 2.7 percent gain in the year-earlier period. Same-store sales are a key predictor of how well the company performs in stores that have been open for several years, and how well the newly open stores will do in the future.

“September sales came in at the low end of our forecasted range of a 1 percent to 3 percent increase, affected by unusually warm weather across our markets and the disruption caused by the updating of 98 stores under our refresher program,” said Fred’s Stores chief executive officer Michael J. Hayes. “We look forward to finishing our refresher program in October with the last 60 stores and to a better economic environment for our customers going forward, as the benefits of the minimum wage increase and the focus of Federal Reserve Board on the credit crunch take hold.”

Fred’s opened four stores at the end of September, bringing total store openings to 22 for the year-to-date period. These new store openings have been balanced by the company’s decision to close underperforming stores. In the remaining months, Fred’s Stores said that it plans to open 14 additional stores, with no further planned closings, which will result in a net increase in stores of 2 percent for the year.

Fred’s Inc. operates 702 discount general merchandise stores, including 24 franchised stores in the southeastern United States.

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Target to open another 61 stores nationwide

BY Allison Cerra

MINNEAPOLIS Target announced that it will be opening an additional 61 Target stores, the company said Friday.

The stores, which will all open Oct. 14, will open in 22 different states. The majority of the stores are making their debut in Arizona, California, Ohio and Texas.

In addition to offering the latest in trend-right merchandise, Target also brings a 44-year tradition of community involvement. The retail chain commits itself to local communities donating more than $3 million each week to area nonprofit organizations, becoming involved in local volunteerism efforts through Target Volunteers, and orchestrating other special projects that help meet area social service, arts and education needs.

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