Here is an analysis of IMKTA that I am working on for my stock club. Let me know what you think.
HALF-THE-HILL INVESTMENT CLUB -
STOCK SELECTION COMMITTEE
February 7, 1998
Ingles Market (IMKTA)
The Stock Selection Committee re-evaluated Ingles Market. Attached is an SSG of Ingles based on the most recent quarterly data. It was at the price we paid for it, rather than its current price, so we could better evaluate the stock's potential return on our investment. The club purchased 100 shares of IMKTA in October, 1996, for $15.736 per share. The stock yields a dividend of 4.3 percent.
Sales and Earnings per Share Growth. The first page of the SSG reveals a historical sales and EPS growth rates of 7.4 and 16.8 percent, respectively. The Committee chose to project future sales and EPS growth at 7.4 percent. We will try to explain why. As you can see by looking at the sales line on the SSG graph, IMKTA has been consistently growing sales at or near 7.4 percent annually every year for which we have data on the company. Therefore, the Committee felt it was reasonable to project the same rate of sales growth into the future.
EPS growth was more difficult to project. By looking at the earnings line on the SSG graph since 1994, we can see that EPS growth has been relatively flat. In fact, EPS dropped somewhat in 1997. The company's most recent 10K reveals that IMKTA has been increasing square footage of its grocery stores by 6.7 percent annually between 1993 and 1997 and that same store sales decreased by 1.5 percent in 1997 over the previous year. Management sites increased competition, low food price inflation (estimated to be less than 1%), and generally soft economic conditions as factor's for last year's decline in same-store sales. Average Sales Per Square Foot was relatively flat between 1993 and 1997 at $299 and $298, respectively. However, sales per square foot have steadily declined since 1995's peak of $321.
In reviewing management's explanations for declining sales, the Committee believes increased competition is the primary factor effecting company's same-store sales decline and that, possibly, Wal-Mart Supercenters may be cutting into their business. In reviewing the industry-wide performance, many grocery stores experienced declines in EPS last quarter. The notable exceptions were Albertsons, Kroger, Safeway, and Winn-Dixie, Ingles' larger competitors. The Committee concludes that IMKTA's future EPS growth should be no greater than sales growth and that sales growth is principally dependent upon the construction/acquisition of new stores (or additional square footage of retail floor area).
The Committee feels that growth in square footage cannot be increased beyond the current rate as IMKTA appears to be heavily leveraged. IMKTA's debt to equity ratio is 1.77. This means Ingles' debts are equal to almost twice its equity. Between 1993 and 1996, IMKTA's debt/equity ratio rose from 1.10 to 1.99. In 1997, the debt/equity ratio fell to 1.77. This was due to the conversion of all of the company's outstanding debentures into stock, which resulted in a 20 percent increase in the number of outstanding class A shares. Although the Committee doesn't know how private lenders perceive Ingle's ability to borrow additional funds, it appears to us that IMKTA has little remaining ability to borrow money for store expansion. Therefore, the Committee forecasts an average annual increase in EPS equal to its revenue growth rate of 7.4 percent. However, even this low rate may be optimistic.
Other Assumptions. The Committee selected the average high and low p/e's of the last 5 years for its forecast high and low p/e's of 15.7 and 10.1, respectively. We used an estimated low forecast price of $9.70 per share. This was the estimated low price as projected by Investors Toolkit (the computer program).
SSG Analysis. As can be seen, management trends are down for both pre-tax profit on sales (which is admittedly down only slightly) and percentage earned on invested capital. The SSG assigns the stock an up-side down-side ratio of 1.0 and projects an average annual return of 11.1 percent. None of these figures meet the club's minimum criteria for stock purchase. In order to meet the 3-to-1 up-side down-side ratio and an annual average return of 15 percent, the stock price can be no higher than $12.50, which is approximately what IMKTA is selling for as of this writing.
Should the club buy more of IMKTA below $12.50 or should we sell and move on to another company?
We suspect that Ingles, as well as a number of other smaller grocery store chains, are experiencing difficulties competing against larger supermarket chains. Ingles recently announced the acquisition of 13 Bruno's supermarkets in Alabama, a chain equal in size to Ingles. Bruno's filed for Chapter 11 bankruptcy during the first week of February. Although IMKTA had $25 million in cash at the end of its fiscal year, we do not know how it is paying for these new stores. Did it use it's cash reserves or did it take on more debt?
Normally, when a company has as much debt as Ingles, we would prefer the company use its income to pay off its debt rather than to pay a large dividend. In the case of Ingles, we suspect that its large dividend is the only thing holding up its stock price. Without it, we would expect the p/e ratio to collapse to something more like 8 or 10, a level which approximates its growth rate. A p/e of 10 places the stock price at $9.60. A p/e of 8 results in a stock price of $7.68.
At least in the short run, the Committee is concerned about the ability of IMKTA to pay its dividend. In 1997, Income before interest, income taxes and the extraordinary item was $64.4 million. Of this, $31.3 million (48.6%) was spent on its debt service. Sixty-eight cents of its $0.96 EPS was used to pay dividends. Looking at it another way, 4Q 1997 EPS was $0.21, of which $0.17 was paid as a dividend. In the first week of February, IMKTA said it expects diluted earnings per common share for the 1Q ended December 27, 1997, to be in the range of $0.12 to $0.14, which is below previously published analysts' estimates of $0.22. It is also below the $0.17 quarterly dividend.
Of additional concern, the company's Chief Financial Officer announced his retirement in the first week of February. While we are uncertain what to make of this, we do not view it as a positive development.
Are these short-term factors which IMKTA can overcome? In the long run, we think IMKTA is doing shareholders a disservice by paying a large dividend when they have so much debt. Although the dividend supports the stock price, and this is a plus, in the long run we feel the company would be better off eliminating the dividend, paying more on its debt, and letting the share price drop. We are uncertain what to think of Bruno's Chapter 11 filing. It should not, at least in the short run, result in the closing of Bruno's stores. Such an event would be a positive for IMKTA, as it would eliminate some of the competition. Still, the positive effect of the Bruno's filing is limited due to IMKTA's highly leveraged position. How many more Bruno's stores can IMKTA buy given its current debt/equity ratio? Many of Ingles' potential competitors (Albertsons, Kroger, Food Lion, and Winn-Dixie) have much lower debt/equity ratios and are therefore, in a better position to buy up the old Bruno's stores. Given the decline in same store sales and its high debt/equity ratio, the Committee is not convinced that IMKTA can compete against the larger chains. Finally, even if we did buy more shares below $12.50, we would still be buying a company which the Committee would normally rule out due to its high debt/equity ratio. The Committee feels there are more attractive alternatives and recommends selling IMKTA. |
