Great Atlantic and Pacific Tea Company: The Glass is Half Full

The Great Atlantic & Pacific Tea Company (GAP) reported underwhelming second quarter results, but regardless, offered a glimmer of hope for the "glass is half full" crowd. GAP produced comparable stores sales growth of 2.8%, resulting in total sales of $2.2 billion. Adjusted "EBITDA" increased from $27.3 million to $67.1 million. The quarter also reflected a $25 million benefit associated with integration synergies realized with its Pathmark acquisition.

GAP was able to reign in its SG&A costs from 30.7% to 30.38%, but incurred a negative gross margin decline of 143 basis points from 31.28% to 29.85%. The bulk of the margin erosion was due to system problems associated with its Pathmark's "Price Impact" Format. Management stressed Pathmark was unable to pass along certain cost increases in a timely manner, hurting operations by $20 million. This issue has been 80% corrected as the third quarter began.

Current liquidity: The company appears capable of riding out the current storm from a liquidity perspective. It has $131 million of cash and $167 million available on its revolving credit line, with none of its debt instruments containing operating covenants. GAP is not subject to debt maturities until 2011. The regional Grocer is also taking a more conservative stance on capital expenditures, reducing its  anticipated spending to the $100-$125 million range.

Looking ahead: Management is optimistic about the future, as it intends to become cash flow positive by the fourth quarter, while having most of its Pathmark transitional issues behind them. The company also has a net operating loss carryover of $480 million, which will be able to be utilized to offset future earnings, thus eliminating potential income tax liability.

Management's take on the share price: Chairman Christian Haub made the following comment during its latest conference call:

Clearly, A&P has seen a unprecedented  decline in its stock price, but this is due to external factors not associated with the actual performance of the company. Factors contributing to the share price decline were heavy short selling (1/3 of the float was shorted during the quarter) and the forced liquidation of a multitude of hedge fund positions. We believe our stock is very much oversold.

Major Shareholder is on a buying spree: GAP's largest shareholder, the Tengelmann Group must concur with Haub's assessment the shares are undervalued. In August, it purchased about 1 million shares in the $17 area, and  then was able to effectively "average down" by nabbing an additional 600,000 shares in the low $6 range, during the last two weeks of October. Tengelmann essentially controls the company with almost a 50% ownership stake, and could attempt to take the company private by making a tender for the remaining shares they do not already own.

Bottom line:  The shares have made a tremendous 66% bounce from last week's all time low of $5.08, closing at $8.27. The huge rally was primarily due to short covering, but also was aided by bargain hunters on the prowl. Although the shares have seen a drastic price improvement, additional upside remains at this juncture, as shareholder's could likely see another 50% appreciation by year's end. The company's 9.375% senior bonds (GAJ) represent compelling value, for those seeking a more conservative approach, as the bonds (aka "quibs") currently produce an attractive 15% yield.

Disclosure : Long GAP, associated ticker symbol: GAJ.

Comments

[bdowsett:]

Thanks Mark - great blog. At what point does the Tengelmann Group have to make their intentions clear. Is there a way that minority shareholders can get hurt in this? (given Christian Haub is both the Chairman of A&P and of the Tengelmann group)

2008 Nov 03 08:52 AM

[Craigla1:]

Mark: GAJ is not a senior note - I believe it's a preferred issue. Please correct me if I'm wrong here.

Thanks.

2008 Nov 10 09:51 AM

[snorake:]

On Nov 10 09:51 AM Craigla1 wrote:

> Mark: GAJ is not a senior note - I believe it's a preferred issue.
> Please correct me if I'm wrong here.
>
> Thanks.


Mark is right
from the company website:
9 3/8% Senior Quarterly Interest Bonds (QUIBS) - GAJ
In August of 1999, the Company issued $200 million senior bonds to mature on August 1, 2039. Interest on the bonds is payable quarterly on February 1, May 1, August 1, and November 1 of each year to the person in whose name the bond is registered at the close of business on the date fifteen days prior to the applicable payment date. The Bonds are listed on the New York Stock Exchange under the ticker symbol "GAJ" and are generally reported in the newspapers under the Preferred Stock Listings as "GtAtlPac Quibs".

2008 Nov 18 08:37 PM

[Ashley B. C...:]

I use to have Direct connect with A&P's top brass. My goal was to push the Company to invest capital in its Southern markets. My correspondence with the company started in 1988 and continued until A&P finally pulls out of most of its Southern US markets Late 90's-2000's.

Chris Haub came into the picture at age 29 and not to his fault did not really understand A&P's former success in most East Coast regions and the let the well established money rollers influence him. So began the same scripted performence statements that you basically here today. The company always tried to blame non union compition in some Southern markets as the reason for lack of performence, But really it was just lack of wanting to invest in doing business in these areas.

James Wood former CEO had put a early 90's bandage on the Southern Operations and things turned around. In fact A&P began to once again expand operations in the South. In 1992 Times Mag. Stated A&P was back and called the Company "The Beast of the East." As the "T Group" though, began to groom Chris Haub to take over, Mr.Wood would eventually be asked to step down.

I was able to set up the Company with a North Carolina Development Firm
in 1997 and things looked very positive. Unfortunately it all fails through when A&P once again began to side line it's Southern Markets as it did during the 70's and Mid 1980's. The result is nearly 95 percent of former A&P locations now flourish as Supermarket Retail locations by other National and Regional Grocery Chains. Chris and the Gang just gave away two /thirds of their market share on the US East Coast and turned themselves into a Minor League Ball Club. It's a shame but it is what it is.

Jan 05 03:09 PM