Winn-Dixie gives off the whiff of an interesting turnaround and a cheap stock. It is a supermarket with stabilized sales, but ephemeral profits. They claim to have hit on the right store format to boost their sales to the necessary scale to earn money for shareholders. The large cash balance, seeming lack of debt, discount to book value and positive cash flow made me take a closer look. This is essentially a case study related to my post on specialty clothing retailers that looks at the broader business of retail and its difficulties.
While retail and supermarkets in specific are simple businesses to understand, operating supermarkets is a difficult business to consistently be successful with. Winn Dixie is good proof of that. They went bankrupt in 2006 and emerged in 2007 after closing 534 stores from 2005-2007. They’ve posted sporadic profits since. This isn’t a post about how they are the next A&P. This is about how 5 years into a turnaround and hundred of millions spent, the company is still struggling.
From fiscal 2008-2011, Winn Dixie has spent $734m in capital expenditures against a current market capitalization of $400m. Revenue in 2008 was $6,975m in 2008 with 521 stores and $6,881m in 2011 with 484 stores. While that is an improvement in unit revenue, it only amounts to growing average revenue per store from $13.31m to $14.2m – 6% growth.
That’s unspectacular when you consider just basic food inflation over that period has been at the same level. So realistically, most of the returns on investment in revenue growth have occurred without any real gain in customers or higher unit throughput in their stores. There is nothing wrong with this in a vacuum, but it reveals that their investments aren’t really investments. It’s just helping them tread water.
Do you realize what a massive sum that is to throw at a problem and get basically nothing in return? This isn’t some jackpot or bust business like A123, a battery technology company trying to establish itself as the battery maker for an electric car future. This is selling people water injected ham, raisin bran, and maybe some Pringles. It's worth reflecting on.
Whatever the company has been doing the past several years has just not worked. Winn-Dixie has a new plan that is supposed to be “transformational”. They are targeting affluent customers who want a superior shopping experience and really rolling out the stops in their stores. They are planning to spend $125m on store remodeling, which includes 17 transformational stores, and an additional $75m on maintenance cap ex in Fiscal 2012. They are still remodeling stores in the same manner they’ve done in the past, while pushing forward with the transformational remodels in certain locations. I don’t know what to make of the somewhat unfocused strategy, but their expenditures in the past have yet to bear much fruit. From the most recent conference call:
As you'll recall we provided extensive updates on our remodel program on the fourth quarter call. We plan on providing a similar update at the end of the fiscal year as well with three status updates on the program each quarter. Our remodel stores are continuing to outperform the chain since the programs inception, 179 offensive remodels has generated a waited average sales increase of 6.7% on a cumulative basis since the grand reopening, which includes an increase in transaction count of 2.9% and an increase of basket size of 3.7%.
And our 51 defensive store remodels, waited average sales has decreased 6.2% on a cumulative basis. However, when you adjust for the impact of the new competition we estimate those stores have generated a waited average sales increase of 4.1% on a cumulative basis. Our new stores have come into the market continues to exceed our sales expectations.
The $1.5m spent on each store on average is misleading because not every store has been remodeled. It’s been closer to $3.2m per store if only the remodels are considered to be the beneficiaries of capital expenditures and in some cases – the defensive models – sales have still declined. I believe Greek poet Homer said it best in regards to results so far, “d’oh!”
What I first thought when I look at Winn Dixie was that at glance they had a net cash position and a turnaround plan. That meant there might be a decent chance of a positive outcome. With $7bn in sales, if they could achieve even a measly 0.50% net profit margin against indebted peers achieving 1%+ margins – all the more achievable since they will effectively never pay taxes due to $1.8bn in NOLs – that would mean $35m in net income, which is about 11x earnings at this price. Not terribly exciting, but worth a look.
If you net out the cash though, you end up closer to 7x earnings with ample growth opportunities by reinvesting in their current stores. Their current store base currently underperforms based on sales per square foot, which is essentially what is driving the poor performance. Even if they achieve margins subpar relative to the industry but start growing revenues, we can entertain even cheaper scenarios with a longer holding period and varying degrees of optimism.
Except that this doesn’t reflect reality. The cash is not unencumbered. To start, Winn Dixie keeps $144m of letters of credit off the balance sheet. This is alright as long as Winn Dixie remains a going concern, but it encumbers the cash. Additionally, Winn Dixie self-insures against certain risks. I don’t quite understand the rationale behind this, but it creates a liability of $185m in reserves. There is no contra asset for this though, so this further restricts the cash on the balance sheet. They can’t give out meat slicers from the deli counter as worker’s compensation. Just to shine more light on the liabilities, there is $1.3bn in operating leases carried off the balance sheet. This all means that the balance sheet offers a lot slimmer of a margin of safety than first glance.
My point is that the cash is simply not a cushion in the valuation or for the company’s turnaround. When I first glanced at the financials, I thought to myself they weren’t doing bad considering they were reinvesting in their stores conservatively by just using their cash flow and maintaining a nice net cash balance. The cash balance exists because it has to as a function of how the business operates, not as a buffer.
I’m going to refer to their preferred measure – adjusted EBITDA – to show how rough it is for even basic improvement in the business to occur. Adjusted EBITDA was $114m in fiscal 2011, $150m in 2010, $164m in 2009, and $101m in 2008. This essentially represents the cash generated from operations that can be reinvested in the company. I don’t think malinvestment is the proper description, but clearly the company is not getting much of its capital expenditures in years past. As they continue to spend on remodeling, declining cash flow is clearly not encouraging.
So the company has been spending tons of money and will continue to do so, yet is barely moving the revenue needle and seeing decreasing cash flow. This doesn’t sound like it's going according to plan. The company had the benefit of a bankruptcy proceeding to tidy up its affairs, a relatively unburdensome set of liabilities, and 5 years of spending to get its house in order. Has it failed? Who knows. As Walmart continues to do what it does, dollar stores begin selling food (and Winn-Dixie sued one of them if that indicates what a threat they see it as), and Publix continues to churn out revenue growth, Winn-Dixie's travails indicate they face obstacles to success of their own making.
While I often roll my eyes at people who claim a company hasn’t done anything in the past years, so failure or inaction will naturally continue in the future, Winn Dixie seems vulnerable to such a charge. Their cash flow has declined despite tons of investment. If such investment isn’t generating positive results after 5 years, what makes year 6 any different? Everyone else is solidly marching forward, while Winn-Dixie flounders.
Winn Dixie is a turnaround where the verdict still isn’t entirely out. Does it look promising? Maybe at a first and fleeting glance. Considering the sums invested already and the results so far, Winn Dixie is in a very rough business with very tough competitors. If anything, it is interesting to see that in what is a mundane industry, even a boatload of money can’t necessarily allow a company to revert to the mean.
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