Spartan Stores: Time to Restock

| About: SpartanNash Company (SPTN)

With the market roiling in credit, housing and consumer woes, now may not seem the time to restock the pantry. Consumer reluctance has taken the shine off most retailers, and the fortunes of Spartan Stores, Inc. (Nasdaq: SPTN) are no exception. But Spartan’s got bones that may bend but not break, making the recent selloff an opportunity to start buying this growing and diversified Midwestern grocer.

Spartan, headquartered in Grand Rapids, Mich., runs a variety of retail grocery stores as well as a large distribution operation. Its key is to grow through supermarket acquisitions and extend its distribution network: at this it has been very, very good. Its total retail base is up 43% since the end of fiscal 2004. Its five-year earnings-per-share growth rate is 15.39%, beating the retail grocery sector’s 12.11% gain. And shares are up about 35% in the past 52 weeks, despite steep losses since the beginning of the month.

Spartan has a solid balance sheet that should help it to shoulder tough times. The company recently added financial flexibility with a $110 million private placement of convertible senior notes, the capital from which will go toward its revolving credit facility and partly to pay for the acquisition of Felpausch, a privately owned grocery.

“In spite of credit market jitters, Spartan is also well capitalized to pursue its growth strategy given the recent $110 million upsized convert offering,” said analyst Karen Short of Friedman, Billings, Ramsey and Co. in a note after release of first quarter fiscal 2008 results on August 1. Its debt-to-total capital ratio on June 23, the end of the first quarter, was 48%, rising from 39% at the end of fiscal 2007 primarily on obligations related to the Felpausch purchase.

Differentiating Spartan is its boardinghouse reach across retail and distribution. Revenues are fairly divided, with first quarter retail sales up 8.8% at $274.3 million and revenue in the distribution segment up 2.4% to $282.4 million. Spartan operates in Michigan, Indiana and Ohio, owning 88 supermarkets and 19 drugstores, including Family Fare Supermarkets, Felpausch Food Centers, Glen's Markets and The Pharm—a deep-discount food and drug store. The company’s distribution segment is the tenth largest in the country, supplying more than 40,000 private label and national brands to its stores and nearly 400 independent grocery stores.

Recognizing consumers’ thirst for accommodation, Spartan now has ten fuel centers, having added four in fiscal 2007. The centers have convenience stores but also are adjacent to company supermarkets. Spartan plans to continue to open several fuel centers over the next few years, through acquisition and new construction. “We expect that the location of the fuel center along with cross-merchandising initiatives will attract customers to the adjacent supermarket, resulting in increased supermarket sales,” the company says in its annual report.
Indeed, a main focus is to leverage its fuel centers and pharmacy operations to drive adjacent supermarket comparable sales. Management focus is on perishables offerings, and it continues to plan on remodels, adjacent acquisitions, expansions and new stores to fill in existing markets. Although it sees room for expansion in its current operating area, Spartan plans to take its model outside of familiar turf longer term, opening even more growth potential.

CIBC World Markets, which this week started Spartan as “Sector Performer,” noted the company is a niche player and aggressive consolidator in the area it serves. “Although we would temper our enthusiasm on the near-term prospects for the share price, we are bullish on Spartan as a company,” said CIBC analysts in an August 14 report. ”It is not unlikely that some surprises could be in store for shareholders down the road – either a major acquisition or a buyout by a national chain interested in an easy entry into Michigan.”

Despite its successful strategy, Spartan Stores, first listed on Nasdaq in 2000, has fallen hard in the market downturn. Shares plummeted from a high of $34.74 July 23 to a low of $21.90 August 9. Since then, prices have recovered to close Thursday at $24.90, giving the company a P/E of 18, based on expectations for fiscal 2007 earnings. Spartan traded as low as $1.45 in January 2003, before its acquisition strategy kicked in, and so has grown up quickly.

FBR’s Short carries an operating earnings-per-share estimate for the current 2008 year at $1.39, up from $1.33 in fiscal 2007 and from $0.96 in 2006. Net sales are forecast to rise to nearly $2.6 billion, after 2007’s year-over-year increase of 16% to $2.4 billion. Short, whose report is dated August 3, retained her buy rating and price target of $32.00 following the quarterly report.

To think “retail” means to think “Wal-Mart” (NYSE: WMT) the discounting giant that is suffering itself from a sales slowdown. There is the risk that Spartan’s market share could be whittled by Wal-Mart, as well as by other large national discount chains. But Wal-Mart’s slowdown in square footage growth should benefit retailers in Michigan, says Short, and consumer demand is remaining stable in the state—“especially given the fact that Spartan’s markets are much less exposed to the auto-related economic woes.” Indeed, demand through June was propped up by Michigan as a vacation destination.

This won’t continue, as Spartan said in its quarterly report that it expects same-store sales to increase in the low single digits for the rest of the year. Same store sales in the first quarter were up 6.3% including fuel sales, or up 3.6% percent excluding fuel sales.

The consumer pullback is one risk; management stability is another. Spartan’s good times depend on staying with those leaders who have grown it into a $540 million company. CEO Craig Sturken, named to the post in early 2003, is considered key. Current management has a very profitable and successful record, but any acquisition is an adventure. Spartan has been prudent in purchasing companies accretive to earnings; an accidental buy could increase the need for capital and hurt the company’s prospects.

Inflationary pressures on food, too, could hinder sales at retail, but the company is well positioned to benefit from a choppy environment given “management’s relentless focus on merchandising and execution, as well as a strong private label program,” said Short.

No matter how unappetizing Spartan looks now, its Midwestern niche as a smaller format supermarket and model of retail combined with distribution remains intact, as do its longer term growth plans. Now all one needs is the stomach to start nibbling on the buy side.

SPTN 1-yr chart


Disclosure: none