A Super-Market Flushed With Cash

Village Super Market, Inc popped up on a couple of my stock screeners throughout the last few weeks and after a cursory overview, I thought it was worth digging into a bit more as a potential candidate for the Voyager Fund. Now that the Voyager Fund sits at an extremely low open risk point, I can afford to take bigger swings at sheer outrageous misspriced companies. After this, you might consider cleaning up on isle profits! (That right there was my attempt at a joke … and yes, I am most likely a better stock picker than comedian).

Business Overview

Village Super Market (VLGEA) owns and operates a chain of ShopRite supermarkets in New Jersey, Eastern Pennsylvania, and Maryland. It is engaged in the retail sale of food and nonfood products. The company was founded in 1955 in Springfield, NJ and has grown into a 3,950 employee operation across 25 supermarkets.

VLGEA went public in 1965. During that time, the company only operated six supermarkets across three cities. Early after IPO, the company was able to leverage its capital to quickly open up two new supermarkets. During the early years of publicity, the company was one of the smallest members of the Wakefern-ShopRite food cooperative. However, by the end of the 1960s, the company turned into one of the highest producing stores, sporting high profit margins, healthy inventory turnover, high sales per square foot, and a stable return on stockholder equity. The 1970s proved a bit more difficult for VLGEA as the birth of superchain stores with slashed prices forced the company to adopt. In an effort to stay competitive, the company offered extended hours and utilized inventory control to minimize their costs. These efforts proved tremendous as the company experienced 20%+ growth YoY from 1977-1978.

What’s even more impressive than the company’s history of resiliency is the low turnover at the top. The company is still principally owned and operated by six members of the founding Sumas family, including their co-founders Nicholas and Perry. I also really like the fact that the company has managed to pay a cash dividend to its shareholders every year since its IPO in 1965. I really like that kind of consistency.

Fundamental Metrics

Before we dig into the recent history of the company, let’s check out some fundamental metrics to get a good base established. VLGEA has a market cap of 325M and an Enterprise Value of 300M, making it one of the smallest players in its industry. The company trades 15x earnings compared to its peer average of 16 and sector average of 25. Not bad. VLGEA trades at 1x book value, which is a steep discount to the sector value of 2.7x. Trading at 0.2x sales, the company is extremely discounted to its sector of 1.4, but not as undervalued to its peers which trade at 0.3x sales.

Let’s move on to size, growth, and profit. The company generates 1.6B in sales compared to the peer average of 14.4B, which makes sense given the smaller nature of the company. The company leads the sector in Diluted EPS with $1.58 compared to its peers of $1.48, and its sector of $1.15. The company has extremely low debt levels of 43.4M compared to its peer average of 1.2B and the sector average of 459M. In terms of growth, the company does have a few red flags. Sales growth came in at -2.1%, and Net Profit Growth came in at -11.7%. The silver lining is the sales 5y CAGR of 2.4%, nice to be positive. The company’s projected Net Income 5y CAGR sits at 37.7%. Moving on to profits. The company’s gross profit of 436M is well below its peer average of 2.5B. Net profit margins sit at 1.4%, ROIC comes in at 9.2%, ROE of 7.8%, ROA of 4.9% (the highest amongst its peers), and ROC of 20%.

The company is trading at 11 times FCF and sports an EV-to-EBITDA of 4.52. Earnings yield comes in at 13.92%, and FCF Yield is 8.8%, 5% higher than the sector average of 3.8%. Looking at ownership, the company has 21% insider ownership, 63% institutional ownership, and a 81.04% float. The top two institutional firms holding VLGEA are Royce & Associates with 12.64% of shares outstanding, and Renaissance Technologies with 5.57% of shares outstanding. BlackRock and Vanguard also hold upwards of 4% of the shares outstanding.

All of those numbers seem nice, but the fact of the matter is this: The company is currently struggling to grow shareholder value in the short to mid-term. Earnings growth (although trending upwards) is still negative, revenue growth YoY is negative, operational & FCF growth YoY is negative, and finally EPS growth YoY is still negative. Can this company ride the ship like it did in the 1970s? For those answers we need to take a closer look at the most recent annual and quarterly reports.

Digging into Financial Filings ($ in Thousands unless Specified)

The following paragraphs will summarize the key bits of information that I found from these reports. The company expects 2018 same store sales to range from -2% to flat. Gross profit as a percentage of sales increased 0.03%, as well as a small increase in gross margins of 0.11%. Operating and administrative expenses increased 49bps in the most recent quarter compared to same quarter last year, primarily due to the decrease in same store sales, coupled with the company’s initiative and training development programs for their employees.

The hit in same store sales was seen in net income, which dropped 27% YoY. A bright light is cash flow from operations, which is showing a positive increase compared to the previous year from ($12,00) down to ($2,000). The company was able to increase its cash reserves from $66M to $75M. Good news is the company expects its cash flow from operations will be adequate to meet its anticipated requirements for working capital, cap-ex, and debt payments for the foreseeable future.

Looking ahead to 2018 and beyond, the company has budgeted out $50MM for capital expenditures. These expenditures include construction of a new store in the Bronx, NY, one replacement store, two major remodels, several smaller remodels, and various technology upgrade projects. Since 2013, the company has deployed capital to remodel most of their stores across the NJ, PA, and MD area in an effort to keep up and stay competitive while providing top of the line customer experience.

Moving on to the latest 10-K, the company experienced a decline in total sales mainly due to a decline in the 4th quarter sales YoY of about $20,000. The company also admits to steep competition within its industry due to the narrower margin business that is the supermarket business. So lets take a closer look at the supermarket business as a whole, and where it could be headed.

Industry Drivers

FMI.org is the voice of food retail, and they put out a great slide deck of the future of the food industry which you can find here. When it comes to shopping for groceries, people still tend to shop around, relying on supermarkets less and less. In 2005, 67% of shoppers relied on supermarkets for their groceries; now its only 47% of shoppers. Most of that traffic is being redirected to either Limited Assortment Stores, other channels, or just the case of people not having a primary store. Natural and organic shopping frequency increased 4% YoY.

What was really interesting was the fact that now 1 in 4 people are using online-only retailers for most of their food products. Nearly half of Millennials are shopping online-only retailers, that’s an 80% increase from just two years ago. Another interesting nugget was the slide on how consumers continue to see their primary store as an ally to their wellness. In other words, when surveyed the question “When it comes to helping you stay healthy, which of these groups tend to be on your side and which tend to be working against you?” People responded with 45% frequency that their ‘primary’ food store is working for them in their quest for well-being.

Trends to Think Going Forward

Some trends worth noting going forward for VLEGA include an increase in their net working capital from -$34MM in 2008, to -$1.2MM in July of 2017. Revenues have steadily increased from 2008 from 1.1B to 1.6B in Oct 2017. Free cash flow generation appears cyclical on the charts, but there has been an increase in the last two quarters. EPS trend is worrisome with an average annual decline of 2.3% over the last seven years.

Potential Catalysts

The company is conscious and selective about how it spends its money for growth, and it appears to have pricing advantages versus its peers considering its relatively high gross margins to the relative average. The company also has the capacity to borrow quickly if needed due to extremely low debt levels. The company is also making efforts to make their stores more wellness – oriented by adding in-store dietician and wellness experts to help shoppers figure out the best way for them to live a healthy life.

Management to me can be a catalyst for this company. The business is still relatively in the Sumas family, with top management positions being help by members of the founding family. The company has tremendous history of delivery shareholder value by paying a dividend every year since 1965.

Intrinsic Business Value & Closing Remarks

In order to get a rough estimate of intrinsic business value, I use a 10Y discounted cash flow growth model. The inputs into this model are revenues (which I am assuming a negative -2.0% growth in 2018, and 0% growth from 19 – 22. Using a low, mid, and high perpetuity growth rate of 1, 2, and 3%, we arrive at a fair value range of $32.57 – $39.75. This is supported by a 10Y average EBITDA margin of 4.1%, as well as a 29.6% unlevered FCF 10y CAGR. This is before adjusting the tax rate assumption. Interestingly enough, the company still trades at a 25% discount to its current value when assuming their 40% tax rate burden. However, this could be impacted by the pro-business White House Administration, and that number will very well likely decrease over time. But for the time being, we will keep it at 40%.

In closing, this isn’t an extremely convicting trade for myself, but its one where I can see the potential for an increase towards intrinsic business value compared to the current share price. Let’s look at the charts to see if we can get a good entry point.

Getting Technical

Right now the share price is holding support at the 22.50 – 22.55 level on the weekly charts. I would like to see confirmation of this hold at support before taking a starter position. I would then continue to add once price broke through the descending part of the triangle.

In a fiercely competing business environment, VLGEA may be positioned well to take advantage of its ‘niche’ market appeal, being able to cater to its more concentrated client base, use its financial flexibility to make the necessary adaptations to stay competitive, while at the same time improving their technology and use of online sales.

 

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