Description

Penn Traffic operates supermarkets primarily in Pennsylvania and upstate New York. They filed for bankruptcy in May of 2003 as a substantially larger entity and emerged in April of 2005.

The capital structure is still not fully unknown as some equity could still be distributed (the company is trying to get these claims rejected and seems confident). I believe that 8.6m shares is the most likely outcome but 9.1m is a possibility, so we can use that share count. There is net debt of $45m; this gives an enterprise value of $195m. Ebitda is projected at $45m for 2006, so the base case valuation is 4.3x ebitda for a company that has rationalized its store base (now in smaller areas with less competition from WMT, eg), the comps trade at 6x, and consolidation is a very real possibility (especially from Ron Burkle/Pathmark).

The company owns 21 of its locations and 5 strip malls. The company has already done a sale/leaseback for some of its assets while in bankruptcy, and has shown an inclination to do the same with these remaining assets. I have seen estimates of $100-200m of value for these real estate assets, but I think this is aggressive. I am using a value of $40m of proceeds from the transaction, with additional rent expense of $4m.

This gives a pro forma valuation of 3.6x ebitda (or 3.4x if you use the 8.6m share count). This is based on $45m of ebitda, which is the amount from 2004. The disclosure statement projects an increase of ebitda to $62m by 2007. Using this (probably hopelessly optimistic) estimate, the multiple is 2.4x.

Why am I using the 2004 ebitda instead of a more recent number? Well, because the company still hasn’t filed their financials. This is related to the fact that the government is looking into the company’s promotional and allowance practices, for which the company recently fired a few of their marketing executives. This is a risk, but it’s unclear how serious it is to the economic future of the company. Meanwhile, the opacity is holding down the stock as people wait for the financials to come out, though three smart funds— King Street, Southpoint, and Triage— are large holders and King Street continues to regularly increase its holdings in the open market.

So, what is the upside? If I am conservative on my real estate valuation, or the company gets taken out at 7x ebitda, the stock is worth over $40. I think a reasonable upside though is $40m for the real estate and 6x 2004 ebitda (pro forma for $4m higher rent expense), which gives a $29 price, roughly 80% higher from here. I’m not sure what the downside is at 3.5x ebitda, but there could definitely be volatility if the allowance investigation isn’t wrapped up neatly (I’d love to hear peoples’ thoughts here).

Catalyst

financials are filed
sale/leaseback happens
Burkle/ private equity/ someone else bids
shares get listed
analyst coverage