Finding Value In Selling Food

October 8, 2010

Regional supermarkets have been hurt recently by several factors. First, increased competition from super retailers like Wal-Mart/Sam’s Club (WMT), Target (TGT), Kroger (KR), Safeway (SWY) and Costco (COST) have forced the regional supermarkets to compete on price where before they could just focus on better quality and service. Secondly, the recession has reduced foot traffic, order size and forced many shoppers to trade down. Finally, due to increased competition and the recession, supermarkets have been unable to pass along increased wholesale prices caused by escalating commodity prices. The future does look grim, but the region supermarkets tend to have a tendency to be very focused and very well. If you believe these supermarkets can fight through these tough times, below are a few ideas that may be compelling values.

Winn-Dixie Stores, Inc (WINN) is the largest chain I am going to discuss currently operating 485 stores in Florida, Alabama, Louisiana, Georgia and Mississippi. The stock price has been crushed and is now trading at its lowest levels in years after the company announced a weak profit forecast as it gets more aggressive on price cuts to increase slumping foot traffic. Increased competition from Publix Supermarkets (PUSH.OB) and Wal-Mart (WMT) also prevented the company from passing along higher costs for meat and dairy. The company has been active trying to make itself more competitive by completing 230 store remodels by June 30, 2010 and closing 30 underperforming stores by the end of September 2010.

The financial results for fiscal year ended June 30, 2010 were anything but stellar. Sales were $7.2 billion down 1.6% from 2009 while comparable store sales dropped 2.9%. Adjusted EBITDA for fiscal 2010 was $144.6 million compared to $164.2 million in 2009. The decrease in EBITDA was primarily the result of lower sales that were not able to be offset by higher gross margins and lower operating expenses.

The balance sheet is solid with $152 million in cash and no long-term debt. The company owns 8 of its stores and 1 distribution center. All other facilities are leased including it corporate headquarters.

Winn-Dixie has traditionally been a low cost retailer, but with extensive remodels and a few new stores, the company seems to be repositioning itself in the upper scale class of supermarkets. This may prove to be the right strategy. As the economy improves, shoppers will generally demand and pay for higher quality products and shopping experiences. While this turnaround will take some time and has several dependencies, it could make this stock a deep value with good long-term growth prospect ahead.

Ingles Markets, Inc. (IMKTA) is a large regional chain operating 202 supermarkets in Georgia, North Carolina, South Carolina, Tennessee, Virginia, and Alabama. The stock is trading at the higher end of its 52 week range, but it is still well below its historic highs. This is a very different story than Winn-Dixie as Ingles earnings did slip in 2008 and 2009, revenues continued to hit all-time records highs. Sales have continued to rise in 2010 and earnings appear to be stabilizing.

The company did report much higher earnings for the third quarter ended June 26, 2010, but be careful. A closer look at the financials reveal a $10.2 million charge related to early retirement of debt in 2009 and a large increase in other income in 2010 which contains primarily the sale of waste paper and packaging. Income from operations was actually down slightly. Most significant in the third quarter was the continued increase in sales which has allowed the company to keep profits stable. Sales rose 3.5% for the quarter, which is significant for a supermarket operating in a tough economic environment.

The balance sheet of this company takes a little extra explanation. At the end of the third quarter, the company had $53 million in cash and cash equivalents and a whopping $825.5 million in debt. This will certainly make this investment look much riskier than the other low debt counterparts included in this article, but again a closer look is necessary. The company owns a substantial real estate portfolio which I believe is the reason the stock price dropped dramatically from its historic highs. The company owns 72 shopping centers of which 56 contain an Ingles supermarket. In addition, the company owns 92 free standing stores containing an Ingles supermarket, 12 undeveloped sites that could be used for a shopping center or free standing store and several parcels and acreage in and around its shopping centers and supermarkets. The company’s headquarters and warehouse is part of an 810,000 square foot facility that is situated on 73 acres in Ashville, NC. Lastly, the company owns an additional warehouse on 21 acres about one mile form its headquarters, a 46 acre site adjacent to its headquarters, and a 116,000 milk processing and packaging facility on 20 acres.

Ingles is still a family business and as with many other family run public supermarkets there are two classes of stock. The Class A shares trade freely on the open market and have one vote per share. However, the Class B stock does not trade and has super voting rights of 10 votes per share. Robert P. Ingle, the company’s chairman, owns nearly all of the Class B shares giving him control. However, several investors including Mario Gabelli’s GAMECO Investors (GBL), FMR, LLC and most recently Blackrock (BLK) all have reportable positions in the Class A.

Ingles appears to be a very well run supermarket and the real estate assets should certainly support the debt load. The real estate assets are most likely undervalued on the balance sheet, but this value is not likely to be unlocked unless the family decides to make a move. If you are patient, the company will currently pay you a yield of 3.9% while you wait.

Village Super Market, Inc. (VLGEA) is small regional chain operating 26 supermarkets in New Jersey and Pennsylvania under the ShopRite banner. The company is a member of Wakefern Food Corporation. Wakefern is the nation’s largest retailer-owned food cooperative. The company is the second largest member and owns 14.7% of Wakefern’s outstanding stock.

Top line revenue and earnings continued to increase through 2009, but earnings have come under pressure in 2010. However, the company just reported that net income increased 4% for the fourth quarter ended July 31, 2010. Sales also increased 10.2%, but were aided by the inclusion of a 14th week and a store opening.

The balance sheet is conservative with $65.4 million in cash and cash equivalents and long-term debt of $32.6 million. The company does own some real estate, but not on the scale of Ingles. The company owns five of its supermarkets which are all free standing except for one that is part of a shopping center. The company is a limited partner in three partnerships. One of the partnerships owns a shopping center in which the company leases space.

This again is a family run operation with two classes of stock similar to Ingles. The Class A common stock is entitled to 1 vote per share while the Class B common stock has super voting rights of 10 votes per share. The Class B is not transferable except to another Class B holder. The Sumas family owns most of the Class B giving the family 65% voting control.

The companies stock price has been stable over the last few years and the company has a recent history of increasing its dividend to shareholders and currently yields 3.5%.

Arden Group, Inc. (ARDNA) operates 18 full-service supermarkets in Southern California under the Gelson’s Market’s banner. Gelson’s prides itself on superior service, carrying the highest quality products and the best overall shopping experience possible. This focus on the shopping experience is what allows it to succeed in affluent areas such as Newport Beach and Calabasas, California.

Sales and net income were on the rise like many supermarkets until 2008 when both took a hit. The California real estate market coupled with recession really hurt in 2009 as sales dropped 10% compared to 2008. The company’s upscale format has hurt sales in these tough economic times. So far in 2010 things have only continued to decline as sales have dropped 4.6% from the prior year and same store sales fell 5.5% in the quarter ended July 3, 2010. On top of everything else, the company’s negotiations with the union led to wage increases in March of 2009.

The balance sheet is solid as cash and investments totaled nearly $46 million and long-term debt was a mere $1.2 million. In addition, the company owns two properties each with a free standing Gelson’s Market, a shopping center in Calabasas, California which is in part occupied by a Gelson’s Market, a 30,000 square foot office building which server as the corporate headquarters, a parcel of land in Rubidoux, California and several parcels of land adjacent to, or near four of its stores.

The company is controlled by the 85 year old Mr. Bernard Brisken, the Chairman, President and CEO, through his ownership of 57% of the outstanding stock. It is uncertain at this time what the succession plan is for the company and the controlling interest of Mr. Brisken. Gelson’s has its own president so leadership is in place for the company’s primary operating asset, but control of the company stock will be a key issue for investors as Mr. Brisken is not getting any younger.

It is clear the company will continue to feel the effects of continued competition from Wal-Mart (WMT), Kroger (KR), Safeway (SWY) and even Whole Foods (WFMI), however the company caters to an upscale clientele which should recover as the economy begins to expand. The company’s upscale format sets it apart from the rest of the traditional supermarkets and when shoppers are ready to feel good again when they shop, Gelson’s should prosper.

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