On the 17th of February, Ahold Delhaize (OTCQX:ADRNY) (OTCQX:AHODF) reported Q4 and FY2020 results. Even though the results over 2020 were good, share prices took a tumble. The main reason is the weak guidance provided by AD. Nevertheless, there are some very good opportunities for the company. After the decline in share price, I think that shares are trading at, at least 12% undervaluation and rate them a "BUY".
Source: Company
How has the company been doing?
FY2020 was a weird year; on the one hand, we had a lot of companies closing down and working from home, while on the other hand online shopping and grocery stores were booming. AD was part of the second group and saw revenue increase by 12.8% (14.2% at a constant rate) to €74.7 billion. This was better than US peers such as Walmart (WMT) and Kroger (KR) but worse than Target (TGT). However, AD has different geography than its US peers, with around 40% of sales coming from Europe. Furthermore, net consumer online sales improved to €7.6 billion from €4.5 billion in 2019 (of which €4.3 billion from Bol.com).
Source: Annual report
Even though the company had a record year, net income decreased by almost 21% to €1.4 billion. Due to the fact that the company had a record year, it also decided to take some pain this year. AD decided to terminate 4 large multiemployer retirement plans. Overall this is a good move due to the low exchange rate of the dollar and the lower tax rate because of the impact on operating margin. To leave the United Food & Commercial Workers International Union-Industry Pension Fund (the "National Plan") and the United Food & Commercial Workers (UFCW)-Local 1500 Pension Fund (the "1500 Plan"), AD had to pay €559 million and €183 million respectively, as well as a transition payment of €18 million. In addition to this, AD's subsidiary Giant Food agreed with unions to combine the FELRA and MAP pension plans. According to the annual report, the agreement consists of the following components:
- Following the combination of FELRA and MAP, the PBGC will provide financial assistance to the Combined Plan after it becomes insolvent to fund benefit payments up to the level guaranteed by the PBGC. Giant Food will pay the withdrawal liability to the Combined Plan in monthly installments, commencing in February 2021, for the next 25 years.
- Giant Food will create a new single-employer plan to cover benefits accrued by Giant Food associates under the Combined Plan that exceed the PBGC's guarantee level following the Combined Plan's insolvency ("excess benefits").
- Giant Food will create a new MEP with another employer to provide excess benefits for certain other participants in the Combined Plan for whom Giant Food previously assumed responsibility. Giant Food intends to exercise its option to withdraw from this plan, which is currently estimated to be approximately $10 million (€8 million) in total, at some point during the next few years.
To establish these plans Giant food recorded a pension-related liability of €502 million and a benefit obligation of €174 million. The withdrawal of the MEP plans greatly de-risked future liabilities of AD.
Source: Q4 presentation
Even though the pension withdrawal payments influenced free cash flow, AD's free cash flow came in at $2.2 billion for FY2020. This was up 356 million from 2019. The company is using its free cash flow in a very shareholder friendly way. The company will pay a dividend per share of €0.90 over 2020 (up 18%) and is planning to use €1 billion to buy back shares. In total AD is returning €1.95 billion to shareholders (almost 90% of its FCF). However, investors should note that the company pays its dividend semi-annually, an interim dividend in August and a year-end dividend in April the following year. As an example AD paid out 50 eurocents in August 2020 and is paying out an additional 40 eurocents in April 2021. This is not very common in the USA.
Source: Q4 investor presentation
If we look at the debt it stays at a very manageable level. The company had a net debt position of €11.43 billion and reduced gross debt by €891 million to €14.6 billion. The main reason for the decrease was the movement in the dollar and the decrease of the overdraft position of the notional cash pooling arrangement. Also, note that the increase in debt from 2017 to 2018 was due to the change to IFRS 16 leases, everything prior to 2018 has not been restated. The company's gross debt/EBITDA is 2.3 and AD has a credit rating of BBB by S&P (SPGI) and BAA1 by Moody's (MCO). This is a worse credit rating than TGT and WMT but similar to Kroger. Therefore, I am not seeing any problems with this at the moment.
Source: Annual report
Despite the good performance in 2020, AD's guidance for 2021 is unimpressive, to say the least. The company expects mid- to high-single-digit EPS growth compared to 2019 and FCF of €1.6 billion. If we would use the 2019 underlying EPS of €1.70 and use the low range let's say 5%, we should expect EPS of approximately €1.79. This would mean a decrease of 21% over the €2.26 underlying EPS in 2020. Something, I think is very conservative. In addition to this, it means that FCF decreases by €600 million. Take into account that AD paid €592 million for pension plan withdrawals and incremental pension funding in Q4 alone and the outlook looks very bad.
Source: Q4 presentation
Opportunity
The future of AD is focused on a multichannel strategy. In 2020 the company made some big steps forward, hitting its 2021 online sales target 1 year early. The total net online sales increased to €7.6 billion of which €5.6 billion come from Europe. Out of the €5.6 billion, €4.3 billion came from Bol.com and only €1.3 billion came from the grocery stores, of which the majority (over €1 billion) is attributable to the Netherlands.
Source: Annual report
Europe
Bol.com
Source: Company website
Although briefly mentioned AD is not only focusing on groceries in Europe but also operates the largest web shop of the Benelux (Belgium, Netherlands, Luxembourg) in Bol.com. Given that all non-essential retail stores are closed since the new lockdown (14th of December) in the Netherlands, Bol.com has seen a rapid increase in sales. In 2020 Bol.com saw its sales increase by 69.6% to $4.3 billion. At the moment I feel that this part of the company is not properly evaluated. To give you an idea, there are rumors that the second web shop of the Netherlands by sales, minority owned by HAL Trust (OTCPK:HALFF) Coolblue is going to IPO on the Amsterdam Stock Exchange. The estimated value of Coolblue according to analysts is 2 to 2.5 times revenue. If we would use a 2 times revenue valuation for Bol.com the estimated value would be approximately €8.5 billion to €9 billion. The current market cap of AD is €23.9 billion. This would mean that either the grocery business, which is still around €70 billion of AD's revenue, is undervalued at an approximate valuation of €15.4 billion or that the valuation of Bol.com is too high. I'd say the first, as the majority of E-tailers (such as Zalando (ZNDO), THG (OTCPK:THGHY) and Amazon (AMZN)) are having a similar or higher valuation.
Besides the valuation, Bol.com still has a lot of room to grow. The company is currently active in the Netherlands and Belgium, and only recently expanded to the French part of Belgium. So far, the expansion has been successful and the company has already attracted thousands of new third-party sellers. In my opinion, the next step would be to expand to France, given the recent expansion to Wallonia. If Bol.com launches in France and is successful, this would be huge as France's population is more than double the size of Belgium and the Netherlands combined. Therefore, I'd say that there is still enough room to grow and expand for Bol.com.
Grocery business
The grocery business of AD in Europe is currently only producing €1.3 billion in revenue, with the majority coming from Albert Heijn, Gall & Gall and Etos in the Netherlands. I think that there is still a lot of room to grow, given that the pandemic has brought new customers to the online business. Before the pandemic, the majority of online grocery customers were families, while during the pandemic also singles and young adults are starting to shop online. Furthermore, given that the majority of sales is from the Netherlands, AD can still penetrate the markets in Belgium and Eastern Europe. I think that the biggest chance is currently in Eastern-Europe, especially in Romania, Czech Republic and Greece. These countries are not as densely populated as the Netherlands and Belgium. This means that families have to travel further to do their grocery shopping. In addition to this, online shopping is still in its infancy, as less than 50% of internet users in these countries are shopping online.
Source: Eurostat
USA
The USA is still the biggest market of AD and I think that the company can still do a lot better here in terms of online sales. In the USA, the company is currently only getting around 4.4% of its revenue online. To put this into perspective WMT is currently at 5.3% and TGT is fulfilling around 5% of its sales online. I expect that AD will leverage its knowledge from its Dutch brands to use in the USA. Even though the USA's culture is different than the Dutch one, it will definitely be an advantage over going in blank. Furthermore, given that the USA is by far larger and less densely populated, the market will be bigger. However, this will also come with higher transportation costs. Nevertheless, there is still room to grow revenue here.
In that perspective, I view the acquisition of FreshDirect as a move in the right direction. FreshDirect is an online grocer that focuses on fresh and local meats, fish, produce and specialty items. I see this as a good niche for the future given the increased attention to sustainability and local shopping. The company is active in New York City, Philadelphia and Washington DC. I think this is a good start, as the annual income in these regions is on the higher end of the USA.
Source: Forager
Risks
At the moment I see three major risks to AD. The first one is the end of Covid-19, the second one is Amazon, and the third one is the possibility of hiking the minimum wage in the USA.
The end of Covid-19
Although everyone is waiting for this to happen and Covid-19 is a risk to the majority of companies, the end of Covid-19 is a risk to AD. The reason why I think the end of Covid-19 is a risk to AD is that, due to the lockdown of several entertainment venues and restaurants, people did not have a lot of other choices to spend their money. This led to an increase of 17% in grocery spending in the USA and to an increase of 9.5% in the Netherlands. When Covid-19 ends, there will be a lot more options to spend your money and this will most likely lead to a decrease in sales of luxury food items and other grocery items. In addition to this, people will be able to go to the stores again. This will certainly influence sales at Bol.com as people will have more options. I work at a retailer and some of our stores are completely booked throughout the day. This means that if people have the chance, they will return to physical shopping again.
Amazon
Amazon recently expanded to the Netherlands and finally has a Dutch website. However, this could have major implications for Bol.com. Both Amazon and Bol.com have a marketplace and also sell themselves. Amazon has Amazon Prime, while Bol.com has Select. Given the size of Amazon, it would be able to easily compete with Bol.com and would be able to give discounts for an extended period of time, hurting sales of Bol.com. On the other hand, Dutch people were able to use Amazon websites from other countries. This did not impact Bol.com in any meaningful way. Therefore, I currently see the likeliness and impact of this risk as moderate.
Minimum wage
Since January, the Democrats are back in the white house. One of their promises was to increase the minimum wage to $15 an hour. Although this is a noble promise, this will be a risk for a lot of companies. The current minimum wage in the USA ranges from $5.15 in Wyoming and Georgia (If companies are not subject to the fair labor standards act) to $14 in California. The majority of AD's American stores are on the east coast of the USA. The majority of these states are currently still at the federal minimum of $7.25. If Biden's government decides to raise the minimum wage to $15. This would more than double the wage. However, the majority of AD's American employees earn above minimum wage, which lessens the impact of the increase. Based on the given data, I would say that the impact of this risk is moderate to high and the impact will also be moderate to high. Nonetheless, there is a huge correlation between rising minimum wage and inflation, which could ease the impact on AD.
Source: Yahoo Finance
Valuation
In order to determine a valuation, I will first use the dividend yield method. I think this is a decent method, given the fact that the company is A) paying a dividend and B) is growing its dividend (given that AD declares its dividends in euros there might be some FX differences for US shareholders). To make a good estimation of the valuation we will use the 1- and 5-year dividend yield average. As Seeking Alpha provides the dividends in dollars I will use the closing prices from Yahoo Finance and dividend from Dividendinfo (excluding special dividend) to determine the 1-year average dividend yield and I will take the 5-year average dividend yield as reported by Yahoo Finance.
According to my calculations, the average dividend yield over the past year was 3.82%, while the forward yield is 4.13%. This means that based on the 1-year average dividend yield AD is undervalued. If AD would return to its average dividend yield over the past year, the share price would be €23.56. This would imply an upside of 8.5% over the closing price of the 3rd of March. If we take a look at the 5-year average dividend yield, AD would also be undervalued. If it would revert to its 5-year average dividend yield of 3.3% the shares should trade for a price of €27.19. This means that if the dividend yield would revert back to the 5-year average the shares would be undervalued by 25.1%.
Source: Yahoo Finance & Dividendinfo, Author's illustration
Based on the dividend yield the share price should be between €23.56 and €27.19. On the one hand, given the online opportunities and the good performance over 2021, I would say that the company should trade at the high range of the valuation, but on the other hand, AD's outlook for 2021 is weak and there are some major risks to the company. Therefore I would say that the company should trade somewhere in between these estimations. Based on the fact that I think that the opportunities and the fact that, in my opinion, the outlook is very conservative, I would say that the company should trade between a dividend yield of 3.7% and 3.6%. This would mean that shares should trade between €24.32 and €25, implying an upside of at least 12%.
Investor takeaway
AD reported FY2020 and Q4 results on the 17th of February before the bell. The results were good, but were impacted by the pension charges. However, this decreased future risk to the company. In addition to this, the company saw FCF rise to €2.2 billion, and returned almost €2 billion with share buybacks and dividends. However, the outlook for FY2021 was unimpressive, to say the least.
In the near term, there are a lot of online growth opportunities for AD. Bol.com is currently undervalued by the market and the expansion of Bol.com to the French part of Belgium could help in expanding to more countries. Furthermore, the increase in online grocery shopping can help boost sales in the future. Especially given the low rate of people shopping online in Romania, Greece and Serbia. In the USA, there is also room for growth, given that only slightly more than 4% of sales are derived from its online channels. The acquisition of FreshDirect is a step in the right direction in that perspective.
Unfortunately, there are some major risks to the company which include the end of Covid-19 and the reopening of economies, Amazon and the hike in the minimum wage, of which the hike in the minimum wage is currently the biggest risk.
From a valuation point of view, the company is very cheaply valued. Based on the dividend yield theory and my own estimations the company is undervalued by at least 12%. Based on the opportunities and the undervaluation, I currently rate the shares a "Buy". However, American shareholders who are unable to buy on European stock markets should take into account that the OTC shares are a lot less liquid than the European shares.
