UK markets: Cheap but little growth on the horizon (NASDAQ:IMKTA)

Investment Thesis

English Market (NASDAQ:IMKTA) is a small American supermarket that has seen a 25% decline from its all-time highs reached at the end of 2022. This is because during COVID-19 it had higher than normal profits, but now this largely had. normalized.

I’m currently trading pretty cheap, but I’d like to see a better growth strategy before recommending a buy. So I think it’s a holdover.

Business model

It is a small supermarket chain that operates in the southeastern United States, particularly in less populated regions such as North Carolina, South Carolina, Georgia, and Tennessee.

Despite being small, it was founded in 1963, making it the same age as supermarkets like Walmart and older than Whole Foods. However, it clearly did not expand as much as its peers. The following map shows where its 198 locations are distributed, a number it doesn’t have moved at all in the last five years, and that’s a long way from Walmart (WMT) +4,600 stores, Kroger’s (Cr) +1,200 or Whole Foods +500.

This is one aspect I don’t like so much about the company, since I feel like they could be more ambitious and look to expand their footprint. At the end of the day, you can’t just depend on prices rising due to inflation, which is why between 2014 and 2019, revenues only grew by 2% annually.

Hidden value in the balance sheet

One explanation for why the expansion has been so slow (or rather not at all) is that the company usually prefers to buy the properties instead of renting the premises. This requires higher investment to grow; therefore, growth is slower, but it also brings indirect benefits, such as the fact that the company owns properties worth $1.4 billion (the same value as the current market capitalization) because it owns 167 of the 198 supermarkets and, also 29 undeveloped sites.

Therefore, there always remains the possibility to sell the properties and then start renting them out and with the surplus cash start a more aggressive geographical expansion. I don’t think this will happen anytime soon, and there are no signs, but it is a possibility.

The sharing structure

The company has 19 million shares outstanding. As of August 6, 2024, 14.5 million shares were Class A and 4.5 million were Class B. Class B shares are not listed and have higher voting power, so Mr. Robert P. Ingle II (son of the founder Robert Ingle and current chairman of the board) owns almost 23% of the outstanding shares but 72% of the voting power. Meanwhile, CEO James Lanning only holds 1.5% of the voting power, so he doesn’t have as much relevance in the company’s decisions.

The company pays dividends of $0.66 per share for Class A shares and $0.60 for Class B shares; therefore, the payout ratio would be 19% over the trailing twelve months, not the 7.68% indicated in Seeking Alpha, which only considers Class A shares. At the current price, the dividend on Class A shares would have a yield less than 1%; therefore, it doesn’t seem that relevant.

He benefited from COVID-19

For some reason, when the COVID-19 pandemic hit, the company benefited and was able to sell its products at a higher margin than usual. This is especially accentuated in the gross profit margin, which went from 23-24% in the period 2014-2019 to 25-26% between 2020 and 2022.

Clearly, this did not seem to be something sustainable, but it did lead to more cash coming in than usual. Now this margin has already normalized, even being slightly lower than in 2019, which, personally, I think is not permanent either, and is an effect of inflation that is now also starting to normalize. Therefore, I think margins should stabilize at the 23-24% mentioned above.

In a pretty smart move, management knew these high margins weren’t going to last, so it started aggressively paying down debt. Thus, at the end of this positively abnormal period, the company emerged with a cleaner balance sheet and only $221 million in net debt, less than 0.7 times trailing twelve month (LTM) EBITDA or just over 2 times without LTM. cash flow.

They also took the opportunity to reduce shares outstanding by 6%, something they haven’t done since 2013-2015.

So the allocation of capital was reduced to paying down debt, buying property and buying back shares at very specific times. However, I would like to comment again that I think this would be a good time to start growing more aggressively now that the balance sheet is clean and I’m not using the capital for anything else.

ASSESSMENT

Something that may catch the eye of anyone starting to look at Ingles Markets is its low valuation. The trailing twelve month P/E is less than 9, while the rest of the supermarkets typically trade at 20 times on average, so I would like to do a comparison exercise to conclude whether this seemingly low multiple is deserved or not.

In terms of profitability and considering that the gross margin is already normalized, Ingles Markets has the lowest gross margin except for Kroger, although the EBITDA and net margin are good compared to the rest of the supermarkets.

On the other hand, returns on capital and equity are not as impressive and are even lower than those of Kroger, a company with weaker margins.

In terms of growth, Ingles is one of those that has grown its revenue the most over the last 5 years, although in the last year it is one of the least, and it is also the only one that has seen its profitability both affected in the last 3 years, decreasing Net Income, EBIT and EBITDA by double digits during this period.

So while it doesn’t seem like it’s worth a particularly high multiple because it’s not the standout one, it doesn’t seem like the worst either, and 8x P/E multiple (and 11x FY2024 earnings, according to my estimates) are quite low and would be worth a re-rating to at least 12-15 times earnings.

I think this year revenue will be down between 1% and 2% as reported in the first three quarters, which would result in revenue of $5.8 billion for FY2024. Additionally, net margin should normalize to around 2.5%, which would represent net income of $145 million, divided by the 19 million shares outstanding, would represent EPS of around $7.5.

With a P/E of 12, the price per share would be around $90, representing an upside of over 20% to the current price. With a P/E of 15, the price would be around $110, representing an upside of nearly 50%.

conclusion

The company has a fairly solid and predictable business; however, I don’t like that they are not focused on growth with so much headroom in the US and a very controlled debt balance sheet.

Despite this, growth and margins look quite in line with peers, so it currently appears to be cheap, even accounting for normalizing growth and margins, so it could be a buying opportunity. In my case, I prefer to see a fundamental change in the growth strategy first; therefore, I will assign a hold rating.