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Supervalu Inc. (SVU - Analyst Report), one of the largest grocery chains in the US, has posted fourth quarter 2012 earnings of 38 cents per share (excluding non-cash goodwill and intangible asset impairment charges), exceeding the Zacks Consensus Estimate of 35 cents.

The better-than-expected results come as Supervalu remains on track with its business transformation plan launched last year. The company has been trying to turn its business around by closing stores, slashing jobs, selling off some businesses and lowering its debt.

However, Supervalu’s earnings lagged the prior-year quarter earnings by 14% to 44 cents per share (excluding charges related to store closures and employee-related costs, non-cash intangible asset impairment charge, fully offset by a gain on the sale of Total Logistic Control completed in December 2010).

Revenues and Margins

Supervalu’s total sales dipped 5% to $8.23 billion in the fourth quarter from the prior-year sales of $8.66 billion. The reported revenue also missed the Zacks Consensus Revenue Estimate of $8.31 billion.

Gross margin contracted 50 basis points to 22.8% in the fourth quarter 2012 on account of retail price investments, higher advertising spending, and changes in business segment mix. These were partially offset by benefits from lower fuel sales. Supervalu reported an operating loss margin of 3.7% during the quarter, compared with a profit margin of 2.5% in the prior-year quarter.

Segment Details

Net sales at Retail Food declined 4.5% to $6.4 billion in the fourth quarter 2012, as compared to $6.7 billion in the prior-year quarter. Results followed negative same-store sales of 1.9%, store closures and sale of fuel centers. Retail food operating margin declined 30 basis points in the fourth quarter 2012 to 3.2% due to price investments, advertising expense, and the impact of sales deleveraging, partially offset by the company’s cost reduction initiatives.

Net sales at Independent business slipped 5.5% to $1.9 billion in the quarter compared with $2 billion in the prior-year quarter due to the Target Corp. (TGT - Analyst Report) transition to self-distribution and the divestiture of supply chain management subsidiary Total Logistic Control. Independent business operating margin also declined 30 basis points in the fourth quarter 2012 to 2.6% due to Target’s transition, divestiture of Total Logistic Control, and a slightly higher LIFO charge.

Annual Results

Supervalu’s earnings of $1.25 per share (excluding non-cash goodwill and intangible asset impairment charges) slipped 10% year over year, as compared to $1.39 per share (excluding non-cash goodwill, intangible asset impairment charges, store closure costs, severance, labor buyout and other costs) in the fiscal 2011 period. The results were however within the company’s guidance range of $1.20 - $1.30 per share. The fiscal 2012 earnings however exceeded the Zacks Consensus Estimate of $1.22 per share.

Total sales dipped 4% to $36.1 billion in the fiscal 2012, compared with $37.5 billion in the prior-year period. The reported revenue also missed the Zacks Consensus Revenue Estimate of $36.2 billion.

Other Financial Update

Supervalu exited the fourth quarter 2012 with cash and cash equivalents of $157 million versus $196 million at the end of third quarter 2012. Long-term debt and capital lease obligations were $5.9 billion at the end of fourth quarter 2012, as compared to $6.2 billion at the end of the prior-quarter.

Guidance

Supervalu forecasts its fiscal 2013 earnings guidance in the range of $1.27 to $1.42 per share. The company also anticipates total net sales guidance in the range of $35.0 - $35.5 billion, including the reduction of approximately $500 million in sales due to sale of fuel centers.

The independent business segment sales are expected to increase in fiscal 2013. Identical store sales growth, excluding fuel, is projected to be in the range of a negative 1% to 2% for fiscal 2013.

The company plans to reduce debt by approximately $400 - $450 million in fiscal 2013. Supervalu also forecasts capital expenditure of $675 million for fiscal 2013, which includes completion of 100 store remodels and increase of Save-A-Lot stores by 50 stores, including licensed locations.

Supervalu also expects its effective tax rate to be 36% for fiscal 2013.

Recommendation

We feel that the grocery chain along with its peers in the industry is facing tough times as the global economy slows down accompanied by low disposable income of consumers forcing them to spend cautiously. The shift of Target to self-distribution along with the sale of Total Logistic Control will also affect sales in the coming quarters.

Moreover, the Food and Drug Administration (FDA) is increasingly becoming more and more vigilant regarding food and health standards. Adverse publicity regarding food and drugs is affecting consumer confidence and preventing them from buying the company’s products resulting in product and delivery disruptions.

Supervalu operates in a highly competitive market. Moreover, labor unions pose inherent risks for the company and potential labor related issues remain a concern. Supervalu faces stiff competition from Wal-Mart Stores Inc. (WMT - Analyst Report), The Kroger Co. (KR - Analyst Report) and Safeway Inc. (SWY - Analyst Report).

Currently, the stock carries a Zacks #4 Rank (short-term ‘Sell’ rating) on Supervalu. However, we have a Neutral recommendation on the stock over the long-term.

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