The U.S. Army uses a communications format it dubs BLUF, which stands for "Bottom Line Up Front." In the BLUF spirit I offer my conclusion first with my supporting arguments to follow. My conclusion is: RNDY is oversold by institutional shareholders getting out indiscriminately and so it is now at a great entry point for longs in the $4-$5 per share range, based on the company's fundamentals.
Some Major Holders' Selling Drives Insiders' Buying
Two reasons for recent institutional selling of RNDY are likely (1) "window dressing" (to get any large unrealized losses completely off the books for year-end reporting), and (2) the quite common self-imposed prohibition that many funds have against owning any stock with a share price below an arbitrary $5.00. Having fallen to near that level from the $8.50 IPO price of 10 months ago, some institutions likely have been forced to sell all their shares to comply with their own rules. This indiscriminate institutional selling - amplified by trend-riding short sellers - has pushed the shares down to a forward P/E of just 4.1. That is far below what the company's prospects warrant, despite the headwinds it faces. Roundy's management seems to agree, as there has very recently been a spate of insider buying.
Roundy's, Inc. (RNDY), headquartered in Milwaukee, Wisconsin is in the business of owning and operating 159 supermarkets under these five banners:
- Pick 'N Save stores: 93 stores in Wisconsin; primarily in southeast Wisconsin (Milwaukee and Madison urban/suburban mostly)
- Rainbow stores: 33 stores in Minnesota, all in the Mpls/St. Paul area
- Copps stores: 22 stores, mostly near Madison, Wisconsin
- Metro Market stores: 3 fairly upscale stores in Milwaukee and its suburbs
- Mariano's Fresh Markets stores: 8 upscale stores in greater Chicago with anticipated growth of 4-5 stores there annually and minimum local saturation estimated at 25-30 stores
Roundy's also is vertically integrated; its historical roots dating back to 1872 are in grocery wholesaling. Today it continues in this function by serving its own stores with 3 owned distribution centers and 1 manufacturing facility. Roundy's develops it own-branded products at its commissary, which have a strong 21% sales penetration and generally enjoy a very favorable reputation for a store brand. (As a personal anecdote, I am something of a bread snob who used to buy my bread baked fresh at Breadsmith until I discovered that Roundy's "Artisan quality" line of fresh-baked whole grain breads are tastier as well as 27-35% cheaper.)
In 1975, food wholesaler Roundy's made its first foray into grocery retail by opening a supermarket under the Pick 'N Save banner in Milwaukee. Pick 'N Save stores have since grown rapidly to dominate the greater Milwaukee supermarket business with 47 stores commanding a remarkably high 57% market share. (By comparison, Jewel-Osco, owned by Supervalu (SVU), is #1 in the Chicago area with only 31% market share.)
Pick 'N Saves are iconic in SE Wisconsin, dotting the landscape as the dominant supermarket banner. They have risen to prominence, in my opinion, because they are the clear choice for shoppers who want good to excellent prices without a lot of compromise in product quality or customer experience. Pick 'N Save consistently delivers great prices (especially its weekly circular promotions and coupons), wide selection, and clean, bright, roomy, modern stores. I have lived here in Pick 'N Save country for 25 years and usually have shopped there. However I have no loyalty and regularly have shopped all the competition as well depending on which company has the best advertised deals. Usually that is Pick 'N Save. As for the stores, there is nothing about Pick 'N Saves not to like: They range from 26,000 to 130,000 square feet, being modern, bright, well maintained and attractive. Pick 'N Saves all have a quality traditional supermarket feel rather than the "cheap" ambiance imparted by some big box outfits that use tall industrial steel shelving with the unnerving forklifts running about. They also typically have all the traditional supermarket in-store departments such as fresh bakery, deli counter, butcher shop and pharmacy. Many have extensive beer and wine selections.
Roundy's Rainbow and Copps banners follow a "low prices" business model similar to Pick 'N Save, but in their respective geographies. The Metro Market and Mariano's Markets banners however cater to more upscale shoppers who demand high quality and convenience while being much less price sensitive. These banners emphasize a larger selection and higher quality in freshly prepared ready-to-eat foods such as deli take-out meals.
All five banners have thus far demonstrated sustainable profitability. Overall, Roundy's annual sales in recent years have hovered near $4 billion ($88/share) with gross margin at 26% and net profit (backing out any extraordinary items) coming in consistently in the neighborhood of $50 million ($1.10-$1.50/share).
So Why Has the Stock Taken Such a Beating?
So why is the stock market severely punishing this proven leader in such a stable albeit boring business? The stock is priced at a miniscule 4 times next year's earnings estimates. Its market capitalization amounts to less than 3 weeks of the revenue that the business generates. The answer I believe is due largely to indiscriminate selling by major institutional holders - selling begetting more selling mostly because the price was falling. The current $4.45 share price in effect assumes that the worst case future scenario for Roundy's is virtually a foregone conclusion. That is, its earnings must implode due to the changing competitive environment. I argue that the chances of that fate are far lower.
The Changing Grocery Business
The grocery industry is undergoing major change of an unprecedented nature and that has investors very scared. Big box low price leaders such as Wal-Mart (WMT), Costco (COST), Target (TGT) and Meijer have figured out that people shop for groceries far more frequently than they shop for other things. By enticing this high frequency grocery foot traffic into their stores, they can sell much more of the other stuff on impulse. They don't even need to necessarily make money on the groceries if they profit enough on the other stuff. And so Wal-Mart, for example, is renovating, expanding and heavily promoting its Supercenter-embedded supermarkets as well as opening smaller Wal-Mart Neighborhood stores that emphasize groceries. Wal-Mart's low prices steal market share wherever the chain expands, and it has plans to expand its footprint in Roundy's-dominated turf. So do other low price leaders to a lesser extent, namely Meijer (Milwaukee), Woodman's (Milwaukee) and Target (Twin Cities). "Dollar" type stores such as Family Dollar (FDO), Dollar Tree (DLTR) and Dollar General (DG) are also doing well by expanding their grocery offerings.
In short, lots of new grocery retail square footage is sure to come to much of Roundy's turf over the next several years. Some of the square footage must ultimately get weeded out by consumer preferences. Roundy's will have to trim some margins to compete and to concede some loss of market share for sure. The question is how much. Further, though Roundy's is a quite cost-efficient operator that has risen to dominance by delivering both quality and low prices, it does have long term lease obligations and some union labor, unlike some of its competitors. It owns no significant real estate and has $690 million in long term debt, making the equity vulnerable to a serious, sustained downturn in business. (Debt service is approximately $51 million a year, or 25% of EBITDA. The dividend was recently reduced in order to gradually pay down debt.)
Roundy's Strengths Are Being Ignored
Yet there are some important positives that Roundy's possesses which Wall Street is not giving any credit for, including some that can only be seen by its customers or those very familiar with the local competitive landscape here in Wisconsin. Some of these things cannot be discerned from financial reports. These following points I plan to explore in greater detail in forthcoming SA articles where I focus on RNDY:
- The fact that Pick N Save has been able to command such an outstanding market share (historically and currently) is being underestimated. To wit, Jewel-Osco, the #1 market share leader by far in Chicago, has tried more than once over the years to gain a foothold in Pick N Save territory and failed, abandoning its attempts. I remember shopping at the Jewel-Osco stores that were in Milwaukee and not being impressed compared to Pick N Save. If this Chicago #1 market share leader (outselling 2nd place Dominick's (SWY) by almost 3-fold) cannot compete with Pick N Save, then it stands to reason that Pick N Save is a top notch competitor (as I have always felt). Thus Pick N Save seems likely to hold up relatively well against the new competition, compared with how other regional supermarket chains have fared. Relatively well, I would argue, could be good enough to make the stock worth a whole lot more than $5 a share and potentially a multi-bagger from here.
- Pick N Save had experimental promotional and pricing goofs in Q3 '12 that impacted margins and earnings and caused the $.06 miss for the quarter, in my opinion. The stock cratered badly on the earnings miss ($.20 vs $.26 estimated) as Wall Street assumed this portended an earnings trajectory to come due to the increasing competition. However, as a frequent customer able to view the highly experimental promotions of Q3 firsthand (i.e. Monopoly and "customer-centric") I believe Q3 was largely an anomaly. Thus analyst estimates are now likely overly pessimistic for the coming quarters. Let's just say that as a more tuned-in long time customer it was easy to see the dramatic experimentation in promotion and pricing policy during the third quarter and how it was bleeding cash at the registers temporarily.
- Wall Street apparently has given no thought to the fact that store conversions to Roundy's more upscale banners are quite plausible. Unlike certain regional supermarkets that Wal-Mart expansions have decimated, Roundy's possesses proven expertise in two distinctly separate markets: the low price segment as well as the more upscale, service-oriented segment (Metro Market & Mariano's banners). The more upscale Metro Market and Mariano's banners do not have to compete as directly with low price leaders like Wal-Mart as do the Pick N Save, Rainbow and Copps banners. For example, Whole Foods Markets (WFM) are thriving in areas where Wal-Mart's presence is intense since they are not in direct competition. Many current Roundy's stores are actually located in mid to higher income zip codes. In fact, only 9 of Roundy's 159 stores are located in zip codes where the average adjusted gross income (AGI) per tax return is below $35,000.1 Currently 65 of the 151 non-Mariano's stores are located in zip codes where the average AGI per tax return ranges from $55,000 to $132,000. (The eight Mariano's stores are in zip codes whose AGIs average $89,000.) These data suggest that rock-bottom Wal-Mart prices probably won't shift as much market share to Wal-Mart as Wall Street is assuming. Consider that Pick N Save, Rainbow, and Copps' low prices are only marginally higher than Wal-Mart's, on average, while actually undercutting Wal-Mart on many advertised weekly specials. Also, store conversions to the upscale banners could benefit from the fact that the upscale segment allows for higher margins, making up for reduced volume. Lastly, any converted stores would actually only require breakeven profitability to nullify the onus of those stores' long term lease obligations. All of this means that even if things got pretty bad for a number of Roundy's stores, as a whole Roundy's could still remain profitable while it adjusts to the new competition.
- In the event of any given store's sales volume decline to a critical level, Roundy's might creatively partner with various small footprint retailers to generate some sublease income while synergistically driving more traffic to the store through these partners. Look for an article to come with details on this.
- Embedded in RNDY is a great growth story in the Mariano's Fresh Markets banner. With the first of its eight stores rolled out a mere 2 years ago, Mariano's has garnered rave reviews, experienced overflowing parking lots, and quickly achieved robust sales and profitability (adjusted EBITDA at 5% of revenues with room to grow). This banner clearly has resonated deeply with customers and it is a strong growth play that currently is embedded within dirt cheap RNDY shares. The current 8 store Mariano's fleet is slated to increase to at least 25-30 stores in 4-5 years in the Chicago area alone. How great Mariano's Fresh Markets growth potential may ultimately prove to be is anybody's guess. It could very well be in the infancy of a rapid growth story similar to Whole Foods or Chipotle Mexican Grill (CMG).
Roundy's fundamentals discussed above lead me to conclude that a substantial amount of Roundy's profitability has a very good chance of weathering the storm of the new competition. The current P/E of 4 times 2013 projected earnings is justified only if that chance is slim. Given Roundy's proven expertise in executing for the more upscale grocery segment, which is rather sheltered from the new competition, Roundy's future earnings could potentially not just find a level of stabilization but in fact resume healthy growth. This would result in the stock trading far higher and the dividend growing as well. While the company's leverage adds substantial risk, the risk/reward tradeoff is very appealing from this share price level.
1 Data obtained by my entering all 159 stores' zip codes here.
Disclosure: I am long RNDY.
Additional disclosure: I have no positions in any other stocks mentioned.