Issues behind Supervalu sale built over decades

July 28, 2018

Among a litany of complaints an activist investor has leveled against Supervalu and its board of directors recently was the charge that the company has been letting rural and low-income people go hungry as Supervalus independent grocer customers increasingly go away.

This accusation appears in the latest presentation Blackwells Capital filed in a campaign for board seats, although it doesnt appear until deep into a 175-slide presentation. Its a claim so silly that it seems a little like a late-appearing ad in the governors race, after all the decent arguments to the voters have grown stale.

The kernel of truth here is that the core wholesaling customer of Supervalu, its independent retailers, really have been in decline. That just isnt Supervalus fault.

It was, however, Supervalus problem. And what to do about it was the central challenge for Supervalu going back all the way into the 1980s.

The company never quite met the challenge.

A decade ago Supervalu decided the thing to do was to become one of the biggest, which it accomplished in a deal for most of the Albertsons retail chain. Since the date of that deal Supervalu shares are off roughly 85 percent, the deal has been unwound, and its not at all surprising that Supervalu has finally been acquired.

Last week, the Eden Prairie-based company announced a deal in which it will be taken over by the top distributor of natural and organic foods. The buyer, Rhode Island-based United Natural Foods, is going to finish a recent shift for Supervalu, and thats to get out of the retail grocery business.

With some of this recent history it might be easy to forget that at one time no one could think of Supervalu as a grocery store chain; it was a top-of-the-industry wholesaler. The term wholesaler may sound a little old-fashioned these days, but wholesalers still do a lot of the hard work that brings food to the consumers dinner table.

Wholesalers have a big role to play in industries with lots of potential suppliers of products and lots of potential stores that can sell them. The solution for both General Mills and the Main Street grocer was Supervalu, to store all the products, get them on time to stores all over a region and work with store owners on ways to be successful, from merchandising new products to financing upgrades to the store.

Its not a fat-margin business, but its consistently profitable if managed well. The way to make money is by having everything sized just right and busy all day, with just enough buildings, trucks, warehouse employees and forklifts. That also means this is a business where profitability is sensitive to changes in sales volume.

Its a bad day in the wholesale business when a big customer gets acquired and shifts its business to a different wholesaler. Another bad day is when a customer goes out of business.

The U.S. Department of Agriculture regularly tracks grocery retailing, and in its recent reports the independents were still in decline, as alternatives such as Walmart gained business. Sales of the largest 20 grocery retailers exceeded half a trillion dollars in 2016, more than 66 percent of total sales. In 1996 the top 20 had only about 42 percent of sales.

Its important to understand that independent grocer doesnt just mean little mom-and-pop stores, as many independents are as savvy as they come and have continued to do well. Trade publications will count companies like Iowa-based Hy-Vee, the 14th largest grocery retailer in the country, in with the independents. St. Cloud-based Coborns just cracked Progressive Grocers list of the top 50.

One problem for wholesalers is that once a retail company gets big enough it might decide to open its own warehousing operations. To keep making money wholesalers have sought to keep the volume up by supplying their own stores if they had to. Thats why Supervalu was in retailing in the first place.

This debate about how to use retail to offset the erosion of the market share of its independent grocer customers is a very old one for Supervalu. More than 25 years ago, industry analysts were talking to the Star Tribune about how the company had to run retail as something other than as an infirmary for sick supermarkets, as one analyst put it.

This was a jab at the company for its practice of keeping the wholesale volume up by taking over the stores of customers that had quit the business. What the analysts really wanted to see was more growth of the companys winning retail format, Cub Foods.

Supervalus history with its large-format Cub stores goes back to 1980, when it acquired the locally based operation. As the story goes, Cub stood for Consumers United for Buying, and in big letters on the front of its stores, Cub announced its market position: Low Price Leader.

Part of the appeal of Cub was its usefulness not just as a corporate-owned store to generate a lot of wholesaling volume, but as a concept that could be franchised. Supervalus independent grocers facing tough new competitors like Walmart could respond by opening some Cub stores, their own low-price concept.

Supervalu used a similar approach with other retailing concepts, including Save-A-Lot, which it finally sold a couple of years ago. And with the experience the company had in retail, perhaps it wasnt much of a strategic leap to buy more than 1,100 stores in the 2006 Albertsons deal and become one of the nations largest grocery chains.

United Natural Foods, the company that has agreed to buy Supervalu for about $2.9 billion including the assumption of liabilities, has operated a few retail stores. In its latest annual securities filing, it justified them as sort of a wholesalers version of a research and development lab.

This company has a different strategic problem than Supervalu, with roughly a third of last years sales going to Amazon.coms Whole Foods. United Natural Foods needs both capacity as Whole Foods grows and diversification in case Amazon decides one day it can do this job better on its own.

But in a note in which analyst Scott Mushkin of Wolfe Research laid out United Naturals strategic problem, he also summarized in just three words how Supervalus long-suffering shareholders should feel about a buyout at a 67 percent premium to the share price on Wednesday.

Christmas in July! he wrote.

lee.schafer@startribune.com 612-673-4302

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