Winn Dixie: Why the Market Is Wrong Again

| About: Winn-Dixie Stores, (WINN)

Since WINN emerged from chapter 11 nearly three years ago, the company has shown some significant turnaround momentum. They have nearly generated $500 million of EBITDA earnings and remodeled over 170 of its stores. The striking thing about the remodel program is they have been able to achieve one third of their entire store base using nothing but their own cash flow (the company is debt free) yet shareholders have been left holding the bag. The truth is, the share price is near the same levels as the IPO price in Nov of 2006. All this progress and patience results in a big fat “zero return” for the original shareholders. What’s up with that?

Wall Street overreacted on first quarter results: First quarter results were bad, but they were not that bad. In fact, the company was able to still improve its gross profit margin from 27.9% to 28.2% despite a 2% loss in the top line. The company also saw its transaction counts stabilize, though its basket size shrunk due to deflationary headwinds and consumers' lack of overall confidence, especially due to continued pressure on the job market. WINN’s CEO expects the second half of fiscal 2010 will show deflation transform into moderate inflation, while employment and the overall economy will gain additional traction.

The company reduced its EBITDA guidance range to $140 -$160 million from $170-180 million and declined to offer assistance on revenue projections. Hopefully, management this time was clever enough to sandbag expectations (under promise) enough, to enable them to surely over deliver when it is time to report second quarter results.

More cannon fodder for the critics: It was revealed on the conference call that WINN’s $3.5 million impairment charge was related to a write down on two recently remodeled stores. Write offs this soon are certainly disheartening and should not occur. WINN’s EBITDA of about 2% of sales is 300 basis points lower than its peer average of 5%. If there is a silver lining, WINN has ample opportunity for huge improvement. Its competitors on average are producing EBITDA at 2.5 times what WINN is delivering and if WINN is able to just improve by 100 basis points, its EBITDA would rise a staggering 50%.

Analyst question: As I listened to the conference call, the usual esoteric, hypothetical and elaborate questions evolved from the slew of analysts participating, until the line of final questioning came up. The analyst, George Schultze of Schultze Asset Management, asked what we all wanted to hear. (1) Why are the other supermarket operators offering an improved outlook and WINN is not? (2) Wouldn’t it be a better use of corporate funds to reduce the remodel activity and use those funds to purchase back common shares in the open market? (3) Why are impairment charges being incurred against remodeled properties? (4) What G&A amount do you expect to reduce in 2010? (First quarter saw a 70 basis point spike from 27.9% to 28.6%). The CEO attempted to deal with these questions, and did a pretty good job, but in reality, it is really hard to pull a rabbit out of a hat. The bottom line is the CEO’s responses were not what the stake owners wanted to hear.

Bottom line: with a market cap of only $618 million and a total of 515 stores, the market is valuing each store at a paltry $1.2 million each. This fact is even more outrageous when you consider the company is spending up to $2 million on a single remodel project. This low valuation is certainly not warranted and appears to be a classic case of inefficiency in an efficient market. Translation: The market is wrong again and eventually the shares will be priced at much higher levels when the “market” comes back to its senses. Adding more persuasion to the long side, the company is certainly vulnerable as an acquisition target from a larger national operator, such as KR, SWY or SVU.

Disclosure: Long