A Sunny Forecast for Ruddick

 | Mar 15, 2012 | 11:30 AM EDT
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I am always looking for underappreciated constants when trying to identify prospective investment opportunities. How do I define an underappreciated constant? Earlier this week I wrote a column about the connected car. The underappreciated constant was the rapidity in which automakers were bringing the connected car to life beyond the functions offered by Ford's (F) once-cutting-edge SYNC system. Where there is an underappreciated constant in the market, there are often undervalued stocks, because investors have not factored in the earnings power of the items or services a company is selling into an expanding, underappreciated market.

Upon further thought, weather popped into my mind as an ongoing underappreciated constant, specifically, weather that triggers abnormal, positive buying habits by consumers. Regardless of where you stand on global warming (ride your bike to work or gas up the SUV), weather patterns, in my view, have seemed outright odd lately. Massive tornadoes have ripped through the Midwest. Above-average temperatures pretty much existed the entire winter, spurring early consumer demand for full-priced apparel and sports equipment from Dick's Sporting Goods (DKS) and early shipment of Zero Turn mowers to home centers from Toro (TTC). Far be it from me to assume the role of legendary weatherman Al Roker, but Mother Nature is sending us a message and I think it's to brace for a volatile 2012 hurricane season.

Most independent weather forecasts are calling for a tame 2012 hurricane season. To them, tame equates to 12 named hurricanes or tropical storms, down from 19 in 2011 because of a weakening La Nina. I was able to unearth a few forecasters expecting a spike in 2012 storm activity, enough so to spark interest in the possibility that meteorologists modeling for a tame season will be wrong. That is an example of an underappreciated constant, and true to form, there is a cool way to move forward on selecting an idea built around the weather thesis.

The conventional wisdom is to go with proven beneficences of storm damage, such as Home Depot (HD) and Lowe's (LOW). But where's the fun in that? With each of those names having had massive 52-week runs on the back of improving housing data and company-specific attributes, I don't want to overplay a hand. Allow me to counter with grocery store chains -- not just any old grocer pumping out rotisserie chicken at $3.99, but a company that literally has a manageable store concentration along the hurricane-exposed East Coast that and stands to partake in pre-storm hoarding. Ruddick (RDK), a holding company that operates Harris Teeter supermarkets, has caught my attention. Keep in mind a couple of the basics of investing in grocery chains:

  1. View companies experiencing quarter-over-quarter, same-store-sales acceleration favorably, indicating market share thievery in a competitive industry.
  2. Compare gross-margin basis-point changes among companies. Don't get hung up on whether or not the gross margin compresses year over year (which is usually the case). If company A had 30 bps of gross margin degradation and a 5% same-store sales increase, and company B had 60 bps of decline and a 5.5% same-store sales gain, the former is a winner since it grew sales basically in line to the latter and didn't have to give away the store to do it.
  3. Assign greater importance to operating expenses as a percentage of total revenues than gross margin.

Grocery List on Ruddick

  • Logged a 5.3% same-store sales increase in its most recent quarter (accelerated sequentially) on a roughly 40 bps drop in gross margin excluding one-time items; the expense ratio fell to 24.9% of revenues from 25.3% a year earlier. Management stated that its pricing and promotions were effective in driving unit sales, customer visits, and market share. The proof of that call out was evident at competitors; Kroger (KR) and Safeway (SWY) have had two consecutive quarters of same-store sales growth deceleration.
  • Does not have a highly levered balance sheet, unlike most in the grocery store sector.
  • Issued a solid 7.7% dividend hike recently despite guiding to a cautious overall outlook in the 10-Q. I would lean on the dividend increase representing a more accurate assessment of the medium to long-term potential of the company than comments designed to set the bar low for hungry Wall Street analysts.
  • Good to know: Stock made a nice move higher into the start of the 2011 hurricane season (begins on June 1).
  • Shareholders recently voted to change to company name to "Harris Teeter Supermarkets" to better reflect its core business.

The supermarket sector is one that does business on razor thin operating margins and generally won't blow the doors off in terms of earnings growth. By spotting the key areas to focus on and then finding a company that is doing things correctly in that framework, the sector suddenly comes to life with opportunity.

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