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Supervalu Inc. (SVU - Analyst Report) posted third quarter fiscal 2013 adjusted earnings per share of 3 cents, lower than the Zacks Consensus Estimate of 6 cents and the comparable prior-year quarter earnings of 24 cents a share.

The adjusted earnings excludes $26 million worth of after-tax gains related to a cash settlement received from credit card companies, partially offset by $15 million in net after-tax charges related to previously announced store closures.

The lower-than-expected results were due to the disappointing same store sales during the quarter and reduced discretionary spending by consumers in the U.S. due to ongoing economic challenges.

Revenues and Margins

Supervalu’s total sales dipped 5.0% to $7.9 billion from $8.3 billion in the year-ago quarter. The reported revenues also missed the Zacks Consensus Revenue Estimate of $10.9 billion. Lower customer spending due to ongoing economic challenges, as well as aggressive pricing by competitors negatively impacted Supervalu’s sales.

The gross margin contracted 50 basis points (bps) to 21.2% in the third quarter of fiscal 2013 on account of higher advertising spending, investment in the fair price plus promotion strategy and changes in the business segment mix.

Segment Details

Net sales at Retail Food declined 7.4% to $4.96 billion in the third quarter of fiscal 2013, as compared with $5.36 billion in the comparable prior-year quarter. Results were impacted by a same-store sales decline of 4.5%, store closures and sale of fuel centers. The Retail food operating margin declined 40 bps in the reported quarter to 1.3% due to advertising expense and the impact of sales deleveraging, partially offset by the company’s cost reduction initiatives.

Net sales at Save-A-Lot dipped 1.6% to $966.0 million compared with $982.0 million in the year ago quarter. The decline was due to negative identical store sales of 4.1% and recent store closures. The Save-A-Lot operating margin declined 220 basis points in the reported quarter to 3.9% due to negative same store sales during the quarter and increase in administrative costs

Net sales at Independent business remained flat at $1.99 billion in the third quarter of fiscal 2013 compared to the year-ago level. Lower spending by the existing customers hurt sales in this segment. The Independent business operating margin declined 80 bps to 2.5% due to tough pricing environment.

Other Financial Update

Cash and Cash equivalents of Supervalu were $155.0 million as of December 1, 2012, versus $157.0 million as of February 25, 2012. Long-term debt and capital lease obligations as of December 1, 2012, were $6.2 billion, compared with $5.9 billion as of February 25, 2012.

Sellout of Supermarkets as Part of Strategic Alternative

Supervalu has entered into a definitive agreement to sell out 877 supermarkets under its five supermarket chains to Cerberus Capital Management LP for $3.3 billion. The sale includes stores from the Albertsons, Acme, Jewel-Osco, Shaw's and Star Market chains as well as in-store pharmacies under \Osco and Sav-on. The sale is expected to close by the end of March 2013.

Recommendation

We believe that the economic slowdown is causing headwinds for Supervalu as well as its peers. Further, low disposable income of consumers is forcing these companies to spend cautiously. Moreover, the Food and Drug Administration is becoming more vigilant regarding food and health standards due to the increasing awareness among consumers. Increased caution on account of health concerns is affecting demand.

Supervalu operates in a highly competitive market. Moreover, labor unions that have caused havocs at retail chains like Wal-Mart (WMT - Analyst Report) could also affect labor relations at Supervalu.

Currently, Supervalu has a Zacks Rank #4 (Sell), so we are not recommending the shares. You could instead consider investment in The Kroger Co. (KR - Analyst Report), Marks & Spencer (MAKSY) or Whole Foods Market (WFM - Analyst Report) that carry a Zacks Rank #2 (Buy).

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