Description

Description

Established in 1963, Ingles Markets is primarily a small-town grocer that focuses their 200 store locations in six southeastern states within an approximately 250-mile range of their distribution in Asheville, NC. Stores include food, pharmacy, general merchandise, and gasoline. Real estate holdings are considerable and include about two thirds of their stores. Ingles is staffed by 27,000 non-union employees. They also own their own dairy which produces 60,000,000 gallons annually and supplies Ingles Market and others though this is barely profitable. They seek out defensible store locations often as the last area before becoming very remote (think base of mountains etc.). There are no plans for expansion. 

Thesis

1. ·         Significantly undervalued $1 billion market cap recession-resistant business
2. ·         The pandemic has generated greater than 25% FCF yield and has resulted in a doubling of profits
3. ·         Quietly paid down over ¼ of a billion in debt last year (from $840M to $586M)
4. ·         Should continue gushing elevated cash flows for the time being
5. ·         With no plans for expansion, predictable Cap Ex, abnormally low dividends due to corporate policy and anticipated FCF that will significantly exceed further worthwhile debt reduction, IMKTA will have no other rationale choice but to use excess cash to buy back shares for the first time in 5 years 
6. ·         Over 10% of the float has been sold short and this combination has the potential to drive up share prices
7. ·         Added protection comes from an undervalued real estate portfolio
8.          A shy company with no earnings call waiting to be discovered by others besides Michael Burry & Mario Gabelli

The Pandemic Has Catapulted Gross Margins and Net Income

IMKTA has been a cheap company for a while (see upcoming competitors comparison table). Pandemic behavior changes have more than doubled profits by increasing sales but mainly by increasing margins. Prepared foods have wonderful margins and have acted as a substitute for going to a restaurant. Additionally, retail comparable sales excluding gasoline increased 15.1% during fiscal 2020 compared with 2019. The number of transactions (excluding gasoline) decreased 3.1% while the average transaction size (excluding gasoline) increased by 15.8%. Comparing fiscal 2020 with 2019, gasoline gallons sold decreased 6.3% and per gallon gasoline prices decreased 15.6%.

These temporarily higher margins have translated to stunning increases in profits. Their TTM  EPS is $10.61 while their stock price is just over $55 per share so they have a trailing TTM PE of < 5Xs. However, their MRQ margin remains elevated and could remain so for perhaps another year.

Their margin opportunity outside of the pandemic relates to private label products which they are promoting so far with what appears to be limited success.

They also could benefit from vaccine distribution and declining interest payments. Currently, the shingles and flu vaccines are very popular but they have not received the Covid-19 vaccine and its not clear how large the impact will be. Most pharmacies have struggled during the Pandemic with more online pharmacy sales but vaccines must be done in person and can drive profits and margins and people into the stores.

Improved gas sales are likely with the economy reopening.

The Two Company Share Classes Have Caused Dividends To Be Abnormally Low

There are two share classes: A & B. The Bs are not publicly traded and are owned by the founding family and have 10 votes per share. The Bs are convertible to As on a 1 for 1 basis. The COB owns 29% of the company but has over 75% of the voting rights. However, the As do a have a small advantage in that they are guaranteed a 10% premium on dividends compared with the Bs. Consequently, Ingles pays a pathetically small dividend. Last year they paid out 9% of earnings as dividends. My guess is this premium has caused Ingles to keep the dividend abnormally low.

They pay out about $13 million a year in dividends.

Company Debt Has Fallen Dramatically And The Trend Should Continue Due To Excess FCF

FCF went from $50M (2019) to $230M (2020). Last year their staggering windfall profits primarily went to pay down debt. A $1 billion market cap company paid down over ¼ billion in debt in twelve months! 

In 2019 (FY) they paid $47 million in interest. Last quarter (Dec 20) they paid $6 million.  Their highest interest rate debt comes due in 2023 and costs approximately $17 million per year. This year they will be able to call these notes at par effectively lowering the cost of paying of this debt early.

The Senior notes which mature in 2023 have an interest rate of 5.75% have been paid down from $700 million in 2019 to $295 million in 2020. 2021 offers more incentive to pay down this debt as the cost of redeeming is now at par. However, the highest cost debt outside of this bond is 3.75%.

Bond redemption schedule:

FCF was $266 million in TTM. Their margins remain high and they will pay less in interest by $25+ million annually going forward. Their dividends are limited and they have paid down most of the highest interest debt. Since they lack significant growth plans they really have two choices for this year in terms of this massive cash flow that I estimate to be around ¼ $billion:

Pay down more debt that has a lower interest rate and / or buy back shares.

Since FCF Significantly Exceeds Potential Debt Reduction, It Is Logical To Anticipate Share Buybacks

It seems likely to me that they will pay down debt as the cost for doing so has declined and they have $295 million at 5.75% interest. However, they will likely generate more than a half of billion in FCF before those bonds are due in 2023. When will they start buying back shares?

There has been no change in the share count since 2015 which is right before James Lanning became CEO when Robert Ingle, controlling shareholder, relinquished the job but retained the Chairman of the Board role. The company doesn’t award stock options. They simply have too much money and will not be able to only pay down debt.

Michael Burry’s Scion Asset Management bought 111,415 shares in Q4-2020. He has agitated for management to buy back shares in some of his past plays and this one seems to fit perfectly. It seems very logical that they will buy back shares. The only question is when will they make the announcement.

The Short Interest is 10% of the float. It’s not hard to imagine how a stock buy back will be received by the market in a company that Michael Burry is invested in after the GameStop craziness.

To be clear, management has not indicated that they will buy back shares but they barely indicate anything. They have not had an earnings call since the new CEO took over 5 years ago and have responded to my question with non-answers:

We believe our press releases and SEC filings provide a full description of our business and its financial performance.

Ron Freeman

Chief Financial Officer

Current IMKTA Valuations Are Attractive

Their industry is a recession resistant one and Ingles valuations are very favorable compared with their competitors.

A unique aspect of Ingles is their real estate portfolio. They have a long held significant real estate portfolio that is held at book and is certainly worth substantially more than $1.1 billion reported. How much is the portfolio understated? Real estate in North Carolina, South Carolina and George has appreciated over the years. These unencumbered real estate assets, along with the significant debt repayment, give the company flexibility in the future. 

Other positives include over funded self-insurance which I believe has excess funds over debt of $45 million.

Risks

·         Online grocery delivery

·         Weather

·         Competition

·         Rent collection issues

·         Potential rising labor costs

·         COB has >75% of voting rights

Catalyst

·         Stock buyback

·         Potential short squeeze

·         Margins remain elevated longer

·         Vaccine distribution