Description

February 25, 2017

SpartanNash (NASDAQ:SPTN)

Business Description and Thesis

SpartanNash (“STPN”) is the sixth largest grocery distributor in the U.S., serving independent grocers, select national retailers, and food service distributors in the Midwest, Great Lakes, and Southeast regions.  In addition to wholesale distribution, SpartanNash acts as the primary distributor to the Defense Commissary Agency’s (“DeCA”) military commissaries and exchanges and also operates 145 corporate-owned retail grocery stores, primarily in Michigan, Nebraska, North Dakota, and Minnesota.  The business is the result of the July 2013 merger of Spartan Stores and Nash Finch Company and operates three segments: Food Distribution (49% LTM Sales and 71% LTM EBIT), Military (26% LTM Sales and 7% LTM EBIT), and Retail (25% LTM Sales and 22% LTM EBIT).

The market’s perception is that SpartanNash is a no-growth wholesale distributor saddled with an unprofitable military segment and a doomed retail business.  As a result, shares have fallen by half in the past twelve months and is a screaming bargain for a stable, highly cash generative business underpinned by substantial owned assets.  Our view is each of SpartanNash’s three businesses will produce revenues and earnings meaningfully higher than consensus expectations driven by a fast-growing Dollar General opportunity in Food Distribution, private label penetration and territory expansion in Military, and stabilization in Retail.

Reason for Mispricing

SPTN’s stock is down 40% year-to-date and 56% in the past year driven by a combination of industry and company specific factors:

1. Amazon’s entry into grocery with its Whole Foods acquisition has caused the stocks of nearly all grocers to fall, as investors fear a retail apocalypse in grocery.  Grocery stocks fell an average of 7% on June 16th when Amazon announced its acquisition of Whole Foods as investors anticipated the implications of Amazon’s entry into the already fiercely competitive grocery industry.  Grocery shares fell further in late August after Amazon announced its first price cuts at Whole Foods, and as a group, shares have failed to recover.

2. SPTN’s recent Caito acquisition has been poorly integrated, with sales down 1/3 organically from customer losses.  The deal was initially expected to be accretive to 2017 earnings, but turned out to be a major drag.  Additionally, the ramp up of Fresh Kitchen, SPTN’s foray into prepared foods, and customer onboarding has progressed slower than expected.

3. Investors are myopically focused on SPTN’s declining Retail (22% of EBIT) segment—which has suffered from ongoing comp declines, food price deflation, and margin pressure—instead of focusing on the growing and increasingly profitable Food Distribution business (71% of EBIT).  

4. Loss of management credibility, driven by a poor acquisition, management turnover (CFO Chris Meyers left after a year on the job), cuts to initial 2017 guidance, and most recently, dismal 2018 guidance.

Differentiated View

1. SPTN possesses an underappreciated Dollar General business, which generated ~$865M in sales in 2016 (25% of Food Distribution or 11.2% of consolidated sales) and continues to grow.  Despite more than doubling in the past two years, we believe this partnership has further headway with potential to sustain double-digit growth rates for the next several years.

First, SPTN can grow along with Dollar General, which has the potential to nearly double its footprint from 14,000 to 26,000 stores.

Source: Dollar General March 24, 2016 Investor Day

In 2017, Dollar General had exceeded its store growth objective of 1,000 new stores, growing from 13,000 to more than 14,000.  Notably, STPN has grown with its largest customer, supplying 14,100 Dollar General locations per its most recent 10-Q filing compared to 13,000 at the start of the year.

Second, STPN can grow within existing stores by selling more perishables into Dollar General, which has emphasized an increase in cooler (refrigerator) doors.  

Source: Dollar General March 24, 2016 Investor Day

Currently, Dollar General is averaging 17 cooler doors per location but has a pathway to 23 cooler doors per store; recent remodels have as much as 34 cooler doors.

Third, SPTN has a largely untapped produce distribution opportunity within Dollar General, which only has 300 produce/grocery test stores.  These test stores are comp’ing higher than Dollar General’s average base and may be rolled out to further locations, providing greater opportunities for SPTN.  Given SPTN is already making these trips to Dollar General locations, additional volumes per drop should equate to high incremental margins.

Assuming Dollar General makes steady progress toward 26,000 stores and 23 coolers on average, SPTN has the potential to grow its DG business by double-digits each year for the next several years.

2. After declining organically for nearly four years, SPTN’s Military business is on the cusp of a rebound, growing 2.7% in Q4 2017, following a 4.6% decline in Q1 2017, a 6.8% decline in Q2 2017, and a flat Q3 2017.  This rebound is driven by:

1. A $500M to $1.0B private label opportunity, which just began ramping in the Q3.  By year end, SPTN had 450 private label SKUs available, is adding 1,400 in 2018 and ultimately reaching up to 4,000 SKUs by 2020.

2. Additional commissary volumes in the Southwest, following the exit from an existing DeCA provider.  This transition began partly into Q3 2017 and should provide additional tailwinds into 2018.

Source: Company Website: http://www.mdvnf.com/service.aspx

Prior to obtaining the additional Southwest business, SPTN supplied 160 of DeCA’s 238 commissaries.  The addition of California, Utah, Nevada, and Arizona would add an additional 23 commissaries, an increase of 20% which we believe can contribute an incremental $300M-plus in revenues (LTM revenues of $2.1B prior to winning Southwest business).  

3. The end of deflationary trends, which negatively impacted revenue growth by 2-3% in 2016 and into H1 2017.  Recently, deflationary pressures have abated, providing a slight benefit in Q3 and Q4.  Meat and produce pricing trends continue to be inflationary and should provide a tailwind into 2018.

4. The combination of the three opportunities above can add an incremental $900M in sales over the next five years, growing sales from $2.1B to $3.0B (7.4% CAGR).