Description

I'll take the other side of WINN.  I am recommending Winn-Dixie as a long investment.  WINN has some striking similarities to KMRT when it emerged from bankruptcy (which I posted in 2004).  It was a weakened #3 player in many of its markets that was thought to be marginalized and permanently impaired.  It emerged debt-free with a significant cash balance.  It has strategically important locations that could be a back stop for value.

Investment Thesis
While capital investment and execution will obviously be necessary, WINN has the potential to operate profitably and generate significant free cash flow like its grocery store peers.  It is easy to state the obvious negatives about the company.  Yes, it was forced into bankruptcy.  Yes, it was losing share to Publix and Wal-Mart.  Yes, there are significant operational issues that need to be addressed. But most of those concerns are already reflected in the current valuation.  At an EV/sales ratio of only 0.1x, WINN is the cheapest publicly traded grocer by a huge margin.  The average EV/sales ratio for the group is 0.5x.  Even PTMK that also emerged from bankruptcy is being acquired by GAP at 0.25x sales.

Valuation
Market Cap: $960 million
Enterprise Value: $820 million
EV/sales:  0.1x
EV/EBITDA:  7.6x (based on FY07 plan)
FCF yield:  2.5%
Normalized FCF yield:  6.5% (excludes growth capex)

Execution and Turnaround
The changes necessary to turn the business around are obvious, but won't take place over night.  Simply put, WINN needs to give customers a reason to come back to its stores and spend more money.  First, the company needs to refresh its store base.  WINN plans on renovating 75 stores per year.  The renovations will range from simple cosmetic uplifts to significant changes in floor plans depending on the location.  The newer stores will offer a fresher look with more focus on perimeter merchandising i.e., fresh produce, deli, bakery, prepared foods, etc.  Second, the company needs to improve service levels in the stores.  This ranges from greeting customers as they enter the stores to ensuring better in-stocks.  Once again, these are not easy changes to execute, but the company now has a lot more financial flexibility.  At the helm, is Peter Lynch who was the COO of Albertson's from 2000 to 2003.

Upside Analysis
The fact is that the grocery business is a good and stable business.  It wasn't too long ago when Kroger and Safeway were thought to be going out of business because of the impact of Wal-Mart.  The whole peer group is trading at multi-year highs now that the impact of Wal-Mart entering the market has been digested and its rate of growth is decelerating.  While WINN has not provided any specific guidance, the comparables provide a good benchmark for profitability.  The industry average EBITDA margin is approximately 5%.  WINN is effectively at 0% today.  There are really no structural impediments other than scale that should prevent WINN from achieving industry margins at some point.  The bankruptcy plan projects 1.5% margins this fiscal year, but shouldn't be relied upon (implies 7.6x EV/EBITDA) .  EV/sales is probably the best metric for evaluating the upside because of depressed margins.  The math is pretty simple.  At 0.2x sales (vs. industry at 0.5x), the equity value will have 100% upside.

Margin of Safety
The liquidation analysis of Winn-Dixie during bankruptcy suggests value depending on recovery assumptions of $775 to $862 million.  The biggest components of which are cash, inventory, and sale of leases.

Business Description
Winn-Dixie operates 522 stores in Florida, Alabama, Louisiana, Georgia, and Mississippi.  The company closed several hundred under-performing and non-core stores during the bankruptcy process.  During the latest quarter, WINN generated same-store sales of 3.5% (excluding Katrina impacts).

Catalyst