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Ahold (OTCQX:AHONY, OTCPK:AHODF) announced yesterday the company will return an additional 1 billion euros ($1.35 billion) to shareholders via a combination of a capital repayment and a reverse stock split. The announcement was expected by investors, because Ahold disclosed the company would review capital structure in a press release, along with its second quarter results. In this blog I argued Ahold should return more cash to the shareholders, because the company holds almost 4 billion euros ($5.4 billion) in cash. At the end of the third quarter, cash and cash equivalents decreased to 3 billion euros ($4.05 billion). The decline was mostly affected by the purchase of short-term deposits and similar instruments for 683 million euros ($922 million). In fact net debt was still negative 774 million euros ($1.05 billion) compared to a negative net debt of 813 million euros ($1.1 billion) at the end of the second quarter. The announcement of the capital repayment and a reverse stock split will resolve the negative net debt issue for Ahold.

The company

Koninklijke Ahold N.V. operates retail stores, offering food and non-food products in the United States, the Netherlands, Belgium, Czech Republic and Slovakia. Familiar brand names are Albert Heijn, Etos, bol.com, Stop&Shop, Giant Landover and Giant Carlisle. The company was founded back in 1887 by Albert Heijn. Albert Heijn started a small grocery store in Oostzaan, the Netherlands. Throughout the years, the company expanded their business to become a multinational with a current market capitalization of 13 billion euros ($17.55 billion). In 2012 the company generated 32.8 billion euros ($44.3 billion) in revenues and reported 830 million euros ($1.1 billion) net profit. The headquarter is located in Zaanstad, the Netherlands.

Capital repayment and reverse stock split

The announced distribution of cash to the shareholders will be executed via a combination of a capital repayment and a reverse stock split. The combination has two advantages compared to other alternatives like a special dividend or an increase of the current share buyback program. First, the excess cash will be returned faster to shareholders, compared to an increase of the current share buyback program. Second, the return is not subject to 15 percent Dutch dividend withholding tax. Declaration of a special dividend would have been subject to Dutch dividend withholder tax.

At the end of the third quarter, Ahold has 1.01 billion common shares outstanding. The completion of the capital repayment and reverse stock split will reduce the number of outstanding shares by 77 million shares to 937 million. The total number of shares outstanding will decrease even further as a result of the current share buyback program. To complete this 2 billion euros ($2.7 billion) buyback program, the company will buy back at least 107 million shares in the next five quarters, reducing the total number of shares outstanding to 830 million by the end of 2014. All of the estimations above are based on yesterday's shares closing price.

Market reaction

After the announcement of the third quarter earnings and the capital distribution of 1 billion euros ($1.35 billion), shares fell 5.03 percent yesterday (click here to see the earnings report). SNS Securities analyst Richard Withagen stated the capital distribution was on the low end of his estimation and third quarter results were disappointing. Third quarter sales were up 0.6 percent at constant exchange rates to 7.4 billion euros ($10 billion). The underlying operating margin declined to 4.0 percent compared to 4.1 percent in the third quarter of 2012. Ahold's quarterly earnings per share increased to 0.16 euros a share ($0.22 a share). A 17 percent increase compared to the third quarter of 2012.

(click to enlarge)

Valuation

Ahold is facing tough competition in the Netherlands and the United States. Income from continuing operations was 568 million euros ($767 million) over the first three quarters of 2013, compared to 661 million euros ($892 million) in 2012. Market conditions will remain tough, because the historical low consumer confidence in the Netherlands, a fragile economical recovery in the United States and (possible) tempering of quantitative easing. The fourth quarter traditionally is Ahold's best quarter, because of the 'holiday season'. Despite weak market conditions, Ahold should be able to generate 250 million euros ($337.5 million) of income from continuing operations in the fourth quarter. This means my projected full year income from continuing operations is 818 million euros ($1.1 billion).

After the completion of the 1 billion euros ($1.35 billion) capital repayment and reverse stock split in January 2014 and the 2 billion euros ($2.7 billion) share buyback program, total shares outstanding will be around 830 million shares by the end of 2014, based on the current share price. Market conditions will remain tough for Ahold going into year 2014. I estimate FY 2014 income from continuing operations around the same level as FY 2013 income. Given the estimated income and shares outstanding by the end of 2014, earnings per share will be around 0.98 euros a share ($1.32 a share). Considering current share price, Forward P/E ratio is 13.33, lower compared to competitors like Wal-Mart (NYSE:WMT), Costco Wholesale Corp (NASDAQ:COST) and Safeway Inc (NYSE:SWY). Details are displayed in the graph below.

DescriptionAHONYWMTCOSTSWY
Share price$17.59$78.90$123.17$34.58
Est. EPS '14$1.32$5.69*$5.53*$1.73*
Forward P/E13.3313.8722.2719.99
Dividend yield3.40%2.40%1.00%2.30%

* According to Yahoo! Finance's analyst survey

The figures provide an insight in Ahold's valuation compared to US competitors (Ahold's US sales are more then 50 percent of total sales). Forward P/E ratio is the lowest of the four companies, 4.2 percent lower compared to Wal-Mart. The dividend Ahold pays to investors is attractive. Dividend yield based on yesterday's closing price is 3.40%. All three competitors pay significantly lower dividends to their shareholders.

Growth potential

Ahold expects their online sales to be a key factor for future growth. In fact, the company is focusing more and more on their online division. Recently Ahold opened 89 grocery pick up points. Customers can order online and pick up their order at one of the pick up points. The first results are promising. Further, in the Netherlands bol.com and albert.nl reported strong sales growth according to the third quarter press release. Ahold is one of the first grocery stores to invest in online sales on a large scale.

The growth in online sales compensates for decline in traditional sales. Ahold's customers spend less money every time they visit the stores, but are spending more money on an average online order. In my opinion online sales will keep growing for a while, because it is more and more accepted to buy groceries online. Ahold was a pioneer introducing online grocery shopping in the Netherlands several years ago. This experience positions Ahold (better than their competitors) to serve future customer needs in the way we do our shopping on a day to day basis.

Another possibility for Ahold is to make an acquisition. After the completion of the capital repayment, reverse stock split and the buyback program by the end of 2014, Ahold has still enough cash to spend on acquisitions. Where analysts are disappointed about the amount of capital returned to the shareholders, I see potential cash reserves to make an acquisition in 2014. Free cash reserves for acquisitions could add up to be around 2.1 billion to 2.6 billion euros ($2.8 billion to $3.5 billion).

Conclusion

In my opinion Ahold is a good investment at the current price of 13 euros a share ($17.55 a share). Forward P/E is lower than its competitors and the company pays a nice dividend of 3.40 percent. Also, Ahold returned a lot of money to their shareholders through share repurchases and they will do so in the future. The dividend yield and share repurchases will support Ahold's share price at the current trading range between 12-14 euros per share ($16.20-$18.90). Further, I expect consumer confidence to rise in the second half of 2014. This could have a positive effect on Ahold's share price. I target shares to go up 10-15 percent to 15 euros a share ($20.25 a share) by the end of 2014.

Source: What Is Next For Ahold After It Completes Capital Allocation?