I'm Still Cautious On Village Super Market

Summary

• Village Super Market’s stock outperformed the market over the past 14 months due to successful turnaround efforts.
• Village Super Market’s dividend hasn’t been internally sustained in the past two years.
• Village Super Market operates in a hyper competitive industry.

About 14 months ago, I published my first article about supermarket chain Village Super Market (NASDAQ: NASDAQ:VLGEA), which currently operates 29 grocery stores under the "Shoprite" name. In that article, I said that investors should stay away from Village Super Market due to its lousy fundamentals, unsustainable dividend and disadvantageous position relative to big box retailers such as Wal-Mart (NYSE: WMT). Village Super Market's stock advanced 17% vs. 8% for the S&P 500 during the past 14 months (see chart below). Let's examine.

VLGEA Total Return Price data by YCharts

Where's the cash?

In FY 2015, Village Super Market saw an improvement in its revenue and net income of 4% and 507%, respectively, year-over-year. However, Village Super Market saw a free cash flow deficit of $6 million in FY 2015 vs. a positive free cash flow reading of $2 million in FY 2014. Comparable store sales increased 2%. Higher customer traffic and the fact that those customers spent more at those stores demonstrate Village Super Market's ability to bring customers back through the doors and keep them engaged. The reopening of remodeled stores also contributed to top line expansion. Village Super Market got past some taxation issues and experienced lower income taxes, which contributed to higher net income. The settlement of income tax issues with the New Jersey Division of Taxation contributed to the negative free cash flow reading.

Village Super Market's balance sheet remains in good shape. Its cash equates to 23% of stockholder's equity vs. 31% of stockholder's equity when I wrote about it 14 months ago. The company still possesses no long-term debt, other than capital and financing lease obligations and a small note payable, which equate to 18% of stockholder's equity. I like to see companies with long-term debt equating to less than 50% of stockholder's equity.

Dividend not currently supported

Village Super Market's dividend has remained unsustainable for the past two years due to suppressed and negative free cash flow, stemming from increased capital expenditures and extraordinary tax payments. I like to see companies pay out less than 50% of their free cash flow in dividends. In FY 2014, Village Super Market paid out dividends that amounted to 585% of its free cash flow. Village Super Market's free cash flow deficit in FY 2015 meant that the dividend didn't get any internal support that year. Currently, the company pays its shareholders $1 per share per year and yields 3.6% annually.

Lower valuation

Village Super Market currently trades at a P/E ratio of 12 vs. 46 when I first wrote about this company 14 months ago. This is due to higher net income for the reasons mentioned above. This low valuation comes at a time when the S&P 500 is trading at a 10 year high. It also means that its market price risk is way below average, and it may not correct as much, if at all, during an overall stock market correction.

Merger speculation

I discussed the possibility of acquisitions by larger grocery store chains in another article. Village Super Market's low valuation could make it an ideal candidate for acquisition by larger grocery chains such as Kroger (NYSE: KR). However, I am not a big fan of buying shares in a company on the sheer hopes that another company will acquire it at a higher price. You may not get a good enough return to cover transaction costs. Moreover, in the medium term the share price of any given company may fall below your initial investment making it more likely that an acquiring company may buy your shares at a lower price.

Conclusion

My earlier thesis remains unchanged. Village Super Market is in a hyper competitive market. The company remains in a disadvantageous position compared to big box retailers, such as Wal-Mart, that can profitably sell products at a cheaper price due to their ubiquity and the price negotiation power they possess over vendors. Village Super Market's investors may enjoy a short to medium term spike in its share price due to its turnaround efforts, but I am not going trust my long-term investing dollars with its stock.

Analyst’s Disclosure: I am/we are long WMT. 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.