Roundy's Shares Offer Fair Value

 | Mar 06, 2013 | 6:00 AM EST
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Midwestern grocery store chain Roundy's (RNDY) reported solid fourth-quarter results late last week. Sales from its stores, which operate under several banners in Wisconsin, Minnesota, and Illinois, increased 1.4% year-over-year to $982 million, roughly in line with consensus expectations. Earnings were not as strong, falling 37% year-over-year to $0.19 per share -- a figure that excludes the impact of a few one-time events.

The trend we saw at Roundy's throughout 2012 continued in the fourth quarter: Its Mariano's chain in Chicago did fantastically well, exceeding sales and profit expectations while posting double-digit same-store sales growth. The core business in Minnesota and Wisconsin, however, continued to struggle, dragging total same-store sales down 2.1%. The latter region, once underserved by Target (TGT) and Wal-Mart (WMT), is now seeing an onslaught of new competition. Even more discouraging, in our view, was the 3.5% drop in traffic at Roundy's stores.

Free cash flow was also disappointing, falling to $43.7 million during 2012, from $115.5 million in 2011. Because the firm raised large amounts of capital in its February IPO, it was able to reduce its total debt load to $697 million. This will reduce interest expense going forward, and we hope the company uses free cash flow to continue to pay down debt.

Unfortunately for shareholders, we think, the company has put itself in a difficult place, committing to a $0.12 per-share dividend. Assuming $0.48 per share in dividends for this year -- a yield just shy of 8% at current levels -- we simply do not think this is the best use of capital. The company's inability to compete in price wars with Target or Wal-Mart puts it at a huge disadvantage. Returning cash to shareholders, rather than pay down debt and invest in Mariano's while the core business declines, seems a poor choice of capital allocation in our view. Income investors may be tempted by the high yield. But we prefer to focus on dividend growth investing, and Roundy's dividend does not look to us like it is poised to rise.

Going forward, the firm's guidance leads us to believe that 2013 will be quite similar to 2012. Capital expenditures will total $63-$68 million, a slight increase from 2012, while sales are expected to grow 3%-4% and same-store sales to fall 1.5%-0.5%. Adjusted earnings-per-share guidance of $0.88-$1.01 assumes some further margin deterioration. The company plans to open five new stores during the year.

We like CEO Bob Mariano's history as an operator. But Roundy's has two businesses right now: One is good and the other is bad. For the time being, we will be avoiding shares in the portfolio of our Best Ideas Newsletter.

This article was written by RJ Towner and Brian Nelson, CFA.

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