Down 30% - Time To Buy Roundy's?

| About: Roundy's Supermarkets, (RNDY)
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As long time Detroit Bear followers know, I keep a keen eye on Roundy's (NYSE:RNDY). Since my last article on the grocer, shares are down a whopping 30%. With the first repurposed store opening, I figured it was an appropriate time to readdress the flailing retailer.

Store Openings Progressing As Planned

Last week, Roundy's opened its first repurposed Dominick's to Mariano's store in the Chicago suburb of Park Ridge. The location is terrific; a highly visible 74,000 square foot store in the midst of Park Ridge, which boasts an average household income of $91,674 and is neighbored by prosperous Chicago neighborhoods like Edison Park and Norwood Park. So far, the store appears to be receiving positive reception.

As for the other 10 locations, each will be opened in the coming months. The average remodel cost will be around $3 million, bringing Roundy's total investment into old Dominick's locations to $70 million. For comparison, this is equal to 21% of the firm's market cap, but only 7.5% of the enterprise value. This introduces an interesting point: Roundy's is currently saddled with $670 million+ in long-term debt. Frankly, at this time, I cannot imagine lenders underwriting any more debt to the company. It will be interesting to see how the financials shake out when the firm reports results next week.

Equity Offering a Dud

Secondary equity offerings are not always a terrible thing. In fact, for a debt strapped firm like Roundy's, offering stock often makes a lot more sense than adding even greater amounts of financial leverage. However, Roundy's equity offering was a total dud, in my view.

Roundy's offered 10,170,989 shares, with 8,844,339 shares of its common stock sold to the public at a price of $7. This sounds great-theoretically, Roundy's raised $61.9 million in cash. However, only 2,948,113 shares were actually sold by the company; the rest were offered by selling shareholders (i.e. private equity fund Willis Reed). Therefore, Roundy's raised approximately $20.6 million, so the firm did not even raise enough capital to cover remodeling expenses at its new stores.

Ultimately, I think it will be positive to remove Willis Reed from the company. The private equity firm was more interested in reaping large returns of its capital rather than investing in the Roundy's business. Further, it means the equity raise was much less dilutive than it may have appeared from afar.

What's Next?

As I noted earlier, Roundy's reports fourth quarter earnings next week. I am expecting further degradation in the earnings power of the Wisconsin business partially offset by strong performance from new Mariano's stores as well as increased productivity from existing locations. It will be interesting to see what the balance sheet looks like.

In late December, the firm sold 10.25% Senior Secured Second Lien Notes due 2020 for proceeds of $200 million. Needless to say, this is not cheap capital and will cost Roundy's another $20.5 million in debt servicing costs annually. While we can laud the performance of the Mariano's business, Roundy's continues to become a riskier financial enterprise.

The firm needs to either start shedding less valuable assets or consider spinning off one of its businesses in order to make the Mariano's growth trajectory more viable. I think the firm is adding too much leverage, and I am unsure if incremental cash flow will be able to cover higher debt servicing costs while the company plows money into capital expenditures to open new stores. I would hate to see the company neglect reinvesting ample amounts of its cash into existing stores to save money in the short-term. This strategy crushed both Dominick's and Jewel in the Chicago area.

Additionally, Whole Foods (WFM) is expanding its presence in Chicago. The firm purchased 7 locations from Safeway (NYSE:SWY), including several wonderful locations:

  1. 959 W. Fullerton Ave. - Lincoln Park Neighborhood, located next to a key train line, bus route, and DePaul University
  2. 225 E. Grand Ave. - Streeterville neighborhood, wealthy residents, grocery desert
  3. 1 N. Halsted St. - West Loop, high income, across the street from a Mariano's

In short, the absurdly profitable organic grocer will be bringing its A-game to compete against Mariano's, making the competition for wealthy buyers even more robust.

Should You Invest in Roundy's?

At the moment, I am waiting for Q4 results before making an investment decision, but I do not like the current state of the company. The firm has tremendous financial leverage, one declining asset, and mediocre cash generating ability. Furthermore, its crown jewel asset, Mariano's, is being attacked directly by Whole Foods. Whole Foods is not a company I would ever want to battle. I do not foresee much further downside-perhaps $6 at the lowest-but I also do not see much upside at this time.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.