2023-09-07 05:54:22 ET
Summary
- SpartanNash has a fundamental upside based on its operating specifics and recent performance.
- The company's debt-related ratios and interest coverage are not favorable compared to its competitors.
- SpartanNash's transformation program and cost savings initiatives are showing positive signs, but margin improvements are lacking.
- I still continue to view the company as a "BUY" here.
Dear readers/followers,
In this article, I'm going to be reviewing SpartanNash Company ( SPTN ). Since the company dropped 40% when I had my "HOLD" rating, I went "BUY" last time around when I reviewed the business ( Source ). I believe this business has a fundamental upside based on its operating specifics and how it has been performing over the last few months.
Any investment into qualitative food production, logistics or food-adjacent services is not a negative, in my book. These are segments that, just like utilities and similar segments, hold significant upside over time even if we are currently in an environment where such companies are being valued lower and lower, due to increasing risk-free rates, increased cost of debt, and overall inflation and cost increases.
However, SpartanNash stock still has an upside - and here I will show you what has changed in the past few months.
SpartanNash - Food production upside is just a question of time, not timing
Timing is relevant only to me insofar as it enables me to buy a company at a good valuation. The company has been where I would consider it overvalued for some time, only to drop down to levels that I would consider making more sense.
The company is in no way "finished" with its transformative changes. We have a gross margin of just north of 15% - which might sound good, but then you get into EBIT and net margins which might be positive, but they're below 1% for both.
Net margin for the FY22 period is as low as 0.4%, and this company has the dubious honor of being one of those companies with almost 85% of revenue going to COGS.
The company also remains at a very modest interest coverage and other fundamental, debt-related ratios. Here we're looking at 2.51x to interest coverage, and a debt/EBITDA of over 4.4x, or a cash-to-debt of 0.02x (Source: GuruFocus). None of those metrics compare favorably to any one specific comp in this sector, and for cash/debt, the company has one of the worst metrics in the entire defensive retail sector, which compares with businesses such as Sysco ( SYY ), Jeronimo Martins, Ahold Delhaize ( ADRNY ) and other companies which I keep a very close eye upon.
I've been following the company through parts of the current crisis that it is going through. Since the failed takeover bid, the company first crashed back down to earth in a rather spectacular fashion, but it's also enabled value investing to be a valid approach for the business.
The 2Q23 results were in mid-August, and those are the ones we'll focus on in this article. SPTN reported in-line EPS, but missed on revenue - but the company also reaffirmed its annual EBITDA and EPS guidance on an adjusted basis, which comes at somewhat higher levels than the overall consensus.
The focus for SpartanNash or for investors looking to "BUY" SpartanNash should be on the progress of its transformation program. Net earnings increases and net sales increases are all well and good, but these increases were overall, expected. Even almost a doubling of the company's operating cash flow shouldn't be a surprise when you're essentially starting from very favorable comps overall.
The company expects cost savings in its ongoing savings program of around $20M by year-end which is in line with what the company expected to do. There are still worrying signs across the company's fundamentals, which likely are contributing factors to why the business is down.
However the essence of SPTN is still a positive one. It's a good interplay between retail and wholesale food/grocery logistics, where more than 50% of the company is wholesale , with an addressable market in the hundreds of billions.
SPTN IR (SPTN IR)
Now, this is a very low-margin sort of business - no getting around that. That's why I'm only slightly interested in projected top-line growth numbers, such as increases in projected sales due to pricing increases. What interests me here are margin improvements, on any level. Because such improvements are mostly absent this quarter, I can share the sentiment that some analysts have where the company is being traded down slightly.
SPTN IR (SPTN IR)
EBITDA guidance is up somewhat. But this company is still in the middle of a fundamental supply chain reorganization and restructuring - and this part of the company is showing positives. Throughput rates are already up 3%, which doesn't sound much, but this is a sequential improvement, not YoY. The company's capital allocation strategy for investment CapEx is a split of 45% supply chain, 25% into IT/other, and 30% into retail operations. The total investments are higher than expected due to inflationary pressure, which to me isn't exactly a surprise given what we're seeing on the macro side.
However, this also means that the company has a hard time growing. Volumes are actually down for the quarter, but sales are up due to higher pricing. That doesn't mean that any of the margin levels are showing improvements though. Gross margins are down for the company, now at just above 15% of sales.
On the positive side, the company showed cost discipline through a mix of decline in incentive compensation, improvements from the SCM side of things, and other efficiencies. So this is a definite positive, and signs that the plan is working. If we didn't see this, I probably and honestly might not be all that interested.
The company's debt is not a positive at this time, now that rates are as high and growing as they currently are. However, what I would in the end keep an eye on is the progress that the company is making on its transformation - or, if applicable, the lack of progress.
What we're seeing in SPTN mirrors the trends for retail and FMCG almost on a global basis. Store brands and the company's, in this case, SPTN's, own brands continue to outpace the sales increases from national brands. This is likely a result of people adjusting their wallets for the overall economy. I believe we'll see a global erosion of the lower middle class as inflation continues to take its toll, and cost increases for things like gas, electricity, food, and basic necessities don't move back down to levels considered normal only 5-7 years ago. Things will cost more, and people will have to adjust.
For a business like SPTN, that means it can continue to keep pace with sales and likely continue to see at least stable sales, as it's able to offer a diverse set of products at a variety of price points.
SPTN also has one addition that's not to be forgotten in any article where this company is covered - namely the military segment. SPTN continues to maintain its military segment, distributing dry groceries, frozen foods, beverages, and meats to U.S. military commissaries and exchanges. This is somewhat unique, as the company, with the third-party partner Coastal Pacific Food Distributors, is the only delivery solution to service the Defense Commissary Agency to this degree in the entire world.
This is not in itself enough to make the company a "BUY", but it definitely adds to the appeal, all things being equal next to similar companies. SPTN may be smaller in terms of sales and market cap than some of its comps, but it does punch "above its weight" class due to its mix of retail, wholesale and military sales.
Military, in this case, is part of the wholesale food business - important to know when reviewing results.
All in all, I would say the company did well in a difficult environment, and I'll continue to keep an eye on the company.
So why is it undervalued?
SpartanNash - the undervaluation is starting to look really good here
My last price target when I reviewed SpartanNash was an attractive $30/share. Even back at the time of my previous article, the company was at around $20/share, which means that we're now at a very good upside for even a conservative $25/share.
I'm not going to shift my price target for this article. I continue to believe that a working, changed SpartanNash is worth around $30/share. S&P Global would mostly agree with this sentiment, though the 5 analysts that follow the company put the company at a range of $23 to $34/share, with an average of $28/share, down from $35/share since last December.
Why did this share price target decline?
Hard to say. If they didn't account for the current interest rate increases, I would consider that somewhat sloppy. I've been working with a discount rate in the double digits for almost a year at this point.
Despite no material declines in the outlook or in sales/EPS, this company continues to trade down. It is small - less than $1B in market cap at this time, and no credit rating. But it has a good upside.
I'm now going deeper into SpartanNash based on this trend.
SPTN Valuation (F.A.S.T graphs)
Even if we consider the company only valid at trading at around 12x forward P/E, this still implies an annualized upside until 2025E of 20% per year, or 53% in total RoR. That's with an attractive 4.02% dividend yield, which for this industry is excellent. If we go back and look at higher multiples instead of the 5-year average, such as say the 20-year average, that upside to 13.3x P/E goes up all the way to 25% annually, or 70% RoR in a few years. And to those that say 13x is unrealistic - the company traded above those levels all the way up until February of this year.
What we have here is a company that due to macro, inflation, and an ongoing, turnaround is being penalized on the market. Penalizing such a company is completely valid. To this degree, I would consider that perhaps a bit too much.
My $30/share price target implies around an 11-12x P/E for the 2025E period. This is neither exuberant nor unrealistic in my book.
The risk here is that the company's margin will once again deteriorate and that its growth ambitions will not materialize as planned. Macro or segment-specific trends could turn EPS growth less than expected, or even flat, which would influence what I would be willing to pay for SpartanNash. The company's size also means that it lacks the scale that some of the bigger comps in this industry have, so investing here still requires some consideration.
Based on the company being able to achieve this, I'm now adding to my position and giving the company the following thesis.
Thesis
- The company now has an upside to a PT of $30/share, which was my previous PT as well. The main difference is that we're now close to $20/share, as opposed to over $30/share as in my last article. Any working company becomes attractive at the right price, and after a 40% drop, it's time for SpartanNash to become attractive.
- The company is fundamentally appealing - and here, I believe you can actually start buying common shares of SpartanNash, and I recently added more shares to my position in the company as well.
- I value SPTN to a $30/share PT, with a "BUY" rating at the current valuation. This marks a rating change for me for the company.
- I've looked at the current options market, but did not find anything attractive enough for me to invest in - though I'll keep looking and updating if a cash-secured put catches my eye.
Remember, I'm all about:
- Buying undervalued - even if that undervaluation is slight and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
- If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
- If the company doesn't go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
- I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them ( italicized ).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
I consider the company both cheap and has an upside here, and for that reason, I'm holding my thesis at a "Buy" here.
For further details see:
SpartanNash: The Decline Makes The Upside All The More Sweet