One Intriguing Grocer

 | Jun 24, 2014 | 1:00 PM EDT
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Seek and you shall find. One can always find interesting ideas in any market. The trick is determining whether you have found a diamond in the rough or simply something that will stay rough.

I'm still trying to figure that out when it comes to one interesting-looking name: Roundy's (RNDY), a small grocery chain that operates in Wisconsin, Minnesota and Illinois. The firm operates some 170 grocery stores and more than 100 pharmacies, operating under retail banners of Pick 'n Save, Rainbow, Copps, Metro Market and Mariano's.

Roundy's has been in business since 1872. Altogether, the company generates nearly $4 billion a year in annual sales. Net margins are razor-thin, as is the case with grocers, and its profit totaled $35 million in 2013. Shares are currently trading for around $5.50, down from nearly $11, and that values the company at approximately $250 million. The balance sheet is leveraged, carrying more than $600 million in net debt. Its net asset value, at $226 million, turns negative when you consider the $600 million of goodwill on the balance sheet.

Roundy's is all about scale. The company generates more than $100 million per year in operating cash flow, but some of the free cash flow is drained by capital expenditures of $60 million a year. Still, at a $250 million market cap and a $900 million enterprise value, the company could be a very interesting idea if it can leverage its sales scale in order to be profitable.

Annual interest expense comes to $47 million, and this seems to be declining each year, but it's still is a meaningful annual amount that equates to nearly 40% of operating income. There's not much room for error. On the other hand, even small cost-cutting or efficiency-gaining efforts could expand the balloon greatly.

Revenue per share is nearly $90. If Roundy's had minimal or no debt, it would be a gem of an investment, given its cash-flow history. So far, though, 2014 has had a slow start after the company's poorer-than-expected earnings report.

At the moment, management is putting significant focus on building out its premium grocery brand, Mariano's, which looks like a Fresh Market (TFM) or Whole Foods (WFM) type of concept. While that strategy sounds good on paper, the secret is out about Roundy's trying to become a premium grocery offering, and competition is fierce amid Whole Foods's rapid store-opening activity. Roundy's is also eliminating other concepts, such as Rainbow, and it is exiting from Minnesota.

Roundy's has its work cut out for it, and I'm watching from the sidelines for now. What captured my interest was that I had a similar experience years ago with Winn-Dixie, a smallish grocer that had been trading for less than 5% of sales. But Winn-Dixie was a debt-free company, and it didn't take long for a private-equity firm to come and buy it at a nice premium in order to take advantage of the recurring cash flow. Time will tell here, but the company is worth keeping tabs on.

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