Shareholders in regional grocer Roundy's (NASDAQ: RNDY) are still waiting for some upside, with the company's stock price sitting near a 52 week low, down more than 50% over the past year. Roundy's has been hurt by declines in comparable store sales and customer traffic volumes, down 3.9% and 5.3% in FY2014, anecdotally due to rising competition in its markets from major grocery players, like Whole Foods Market (NYSE: WFM) and Wal-Mart Stores (NYSE: WMT).
On the upside, though, management seems motivated to try to turn around the company's fortunes, having embarked on a downsizing campaign that has seen Roundy's exit some of its non-core markets and focus resources on its premium Mariano's brand, a strategy that management undoubtedly believes will lead to profit growth and higher shareholder value. So, at its discounted price, is Roundy's a good bet?
What's the value?
Roundy's is a niche player in the grocery business, operating a geographically concentrated network of roughly 160 stores under a handful of brands, with a major presence in the Milwaukee and Chicago metro areas. Unfortunately, the company's inability to deliver comparable store sales growth has led to less productive stores and saddled the company with relatively poor operating profitability, averaging approximately 3.5% over the past five fiscal years. Consequently, management has chosen to pursue the aforementioned updated strategy of focusing on its premium Mariano's banner, which is expected to eventually account for the lion's share of Roundy's overall store base.
In its latest fiscal year, Roundy's updated strategy failed to produce the desired outcome, highlighted by another decline in comparable store sales, down 2.7%. While the company managed to hold the line with regard to its gross margin, thanks to a greater focus on higher-margin, non-perishable product categories, its operating margin was hurt by greater corporate overhead costs implicit in its larger store base, as well as higher occupancy costs from its further push into metro Chicago. The net result for Roundy's was a roughly 70 basis point decline in its adjusted operating margin, causing it to post a 13.3% decline in operating income.
Looking into the crystal ball
Of course, investors are mostly interested in ascertaining whether Roundy's can find its way to a positive profit growth trajectory in the future. Unfortunately, based on the company's performance in FY2014, accomplishing that feat would seem to be a long shot, evidenced by a 31.0% decline in adjusted operating income during the period that was hurt by the double-whammy of declining comparable store sales and rising operating support costs.
A big part of Roundy's problem seems to be that the big-name grocery players want an ever larger share of the premium segment, an area that has anecdotally been growing at a faster rate than the rest of the grocery business, partially due to rising consumer demand for natural/organic product offerings. Case in point is Whole Foods Market, the king of the natural/organic segment, which is expecting to add nearly 10% more stores to its overall network in the current fiscal year, including a greater presence in the Chicago metro area, Roundy's backyard. As illustrated in the below table, Whole Foods Market generates significantly more production from its stores than does Roundy's, leading to a superior operating margin. The net result for Whole Foods Market is superior cash flow generation, fueling an expansion of its store base and its overall franchise.
|Roundy's Sales/Sq. Ft. ($)||575||578||588||592||596|
|Roundy's Adj. Op. Margin (%)||2.6||3.3||3.9||4.0||3.8|
|Whole Foods Market Sales/Sq. Ft. ($)||973||933||870||805||772|
|Whole Foods Market Op. Margin (%)||6.8||6.4||5.4||4.9||3.5|
Source: Roundy's 2013 10K Report, Whole Foods Market 10K Report, my estimates
Wal-Mart Stores, the nation's leading grocer with a footprint of more than 4,000 stores, is also looking to capture more sales in the premium grocery segment, recently partnering with the Wild Oats brand to bring a significantly greater selection of natural/organic product offerings into its stores. Like Whole Foods Market, Wal-Mart Stores enjoys a better operating margin than Roundy's, which in its case is due to the economies of scale implicit in its massive purchasing operation, a competitive advantage that allows Wal-Mart Stores to deliver on its stated goal of being the low cost provider in most of its markets. More importantly, the company's solid operating cash flow generation, roughly $23 billion in its latest fiscal year, is providing the funding to try to capture more of the premium segment's customers through a major expansion of its Neighborhood Markets unit, a move that should put further pressure on smaller competitors, like Roundy's.
The bottom line
Roundy's is certainly cheaper than it was at the start of 2014, after losing almost half of its market value. That being said, the company's most recent financial results spark little confidence that profit growth is just around the corner, a necessary ingredient for a sustainable move higher for its stock price. As such, investors should probably resist the urge to bet on a quick turn of fortune at this struggling grocer.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.