Stock Interest List Update

I know there is no conflict of interest in the following Interest List idea because my employer told me that he would not invest in it if I offered him "10 times leverage and completely insured downside." That's a deep value idea if I have ever heard one!

Spartan Stores Inc. (SPTN) stock has been pummeled due to the threat of supercenter (think Wal-Mart and Target) competition and because its retail stores are primarily in Michigan. As a result it is trading at 7.4x FY09 earnings and 4.3x EV/EBITDA. I believe there is upside of 25% to the shares. The catalysts include a move to staples from more discretionary retail company names from investors and the demonstration that the Company can work through the economy and supercenter expansions, like it has done in the past.

SPTN was the product of a co-operative that did a reverse merger in order to go public in 2000. Upon going public a number of the co-op members sold shares, most significantly one that was annoyed SPTN was going into retail and sold its whole 750k shares (when the stock was only trading 20k per day). So, the stock has been troubled from its beginning.

SPTN experienced poor performance after going public due to a CEO whose ideas did not work and did not manage retail for the customers, but for the best deals SPTN got from suppliers. New management had to come in 2003 from the Midwest division of Great Atlantic and Pacific Tea Company. The Chairman today is the CEO from back then. In the first quarter at the Company they went from double digit SSS declines to flat. The Chairman said that two more quarters of SSS retail decline at that time and he could not have saved the Company.

The new management team turned retail into a consumer driven business and a “performance driven corporation”. However, in 2005 Wal-Mart was expanding rapidly in the state of Michigan and brought seven supercenters on (exactly what is happening in the next 12 months). The Company claims this hurts the 4, 5, and 6 local grocers, while the 1, 2, and 3 players end up taking share. SPTN is 1 or 2 in all of its markets, according to the Company. So, there is this perfect storm of investors believing MI is just too auto dependent, the competition from the supercenters and food deflation.

SPTN has managed through the same issues in the past and seem prepared to do it again. 4Q provided +1.2% SSS and the 11th consecutive quarter of retail SSS (Company suggesting +0.3% for this year). Management expects GM% to continue to improve, which means continued benefit from mix at retail. Other pushes for FY09 include implementing efficiency improvements in distribution business, seeking expansion opportunities in adjacent markets, and selling the assets of the remaining Pharm retail operation. Meanwhile, SPTN said the distribution sales SSS is “running flattish”.

In the most recent quarter the distribution business, not retail, accounted for 84% of operating income. As an astute friend in Connecticut pointed out, is Michigan really going to go bankrupt and people stop shopping for food? The government does not seem to be allowing it in California.

In conclusion, for a grocer that has shown decent growth, past ability to manage through competitive cycles, and a trailing twelve months return on capital of almost 14% in a year of a sizeable acquisition and economic downturn, I think SPTN is pretty compelling at today’s valuation. SPTN is the cheapest grocer/distributor on an EV/EBITDA basis in the FactSet screenable universe and has the best Return on Assets of the bunch. If the market sees any move to staples or indication that the Company is dealing with the competition, this will be a solid Long. As such I placing it on the Long Interest List at $12.41/share.

-2outof4