Description

Summary

WINN has been written up in the past as a long so we thought it made sense to present an opposing argument.  We think WINN is a short.  The most recent WINN write up done by spence774 includes an excellent business description so I will defer to that for background on WINN.  While it is over two years old, it still applies today except for some updated numbers which I will provide.

The core of our thesis is that as a supermarket with strong competitors, WINN has to constantly spend on its store base in order to remain competitive, maintain margins and possibly grow sales.  However, even if WINN spends the money, success is not guaranteed but they still must spend.  So in the end, very little value accrues to shareholders as all of the company's earnings over time are paid out in the form of CapEx to contractors.  Our thesis can be broken down into five key points: 1) WINN is at best fully-valued and is most likely overvalued, 2) WINN's business has provided a negative return on capital invested, 3) WINN's top line growth has been anemic, 4) the performance of WINN's offensive remodels has begun to deteriorate , and 5) the company has been reducing expectations.

WINN is Overvalued

So you're probably thinking, "WINN is trading at an absurdly low 3.5x the low end of management's $140-$160mln FY 2010 EBITDA guidance range, how could it possibly be overvalued."  Well, that is correct, the stock is trading somewhere around 3.5x FY2010 Adj. EBITDA guidance.  But is this stock as cheap as it appears?  Our view is that it is not.  Let's look at the facts.  The EBITDA multiple, however low, is irrelevant.  What is relevant is how much of that EBITDA number is actually accruing to the shareholders of the company.  Well, let's see:

Company Adj. EBITDA Guidance:              $140mln (WINN's latest guidance: "low-end of $140-$160mln)

Less est. FY2010 Interest Exp Net:           $(5.0)mln (2x first half interest exp.)

Less est. FY2010 Cash Taxes:                 $(0.0)mln (WINN is not a cash taxpayer currently-big NOLs)

Less est. FY2010 CapEx:                         $(200.0)mln (WINN's latest guidance)

FY2010 Cash accruing to Shareholders:     $(65.0)mln

One could argue that I am being a little harsh here.  I shouldn't hit the company for the $200mln in CapEx as that is a temporary number and it will drop significantly once they complete their remodel program.  I think that spence774 said in his write up that maintenance CapEx was around $75mln per year.  Alright, so let's use $75mln instead of $200.0mln.  If we do that, the cash accruing to shareholders is $60mln.  OK, I'll have a little more to say about that but for now let's value the company using the $60mln number and see what we get.

Current WINN Market Price:                      $11.20

Shares Outstanding:                               55.0mln

Equity Value:                                          $616.0mln

Less Cash:                                             $(155.0)mln

Plus Debt & Cap Leases:                          $35.0mln

Enterprise Value:                                     $496.0mln

Cash Earnings:                                        $60.0mln (assumes maintenance CapEx of $75.0mln)

Cash Earnings Multiple:                            8.3x

Cash Earnings Yield:                                12%

OK, OK, maybe 8.3x cash earnings could be considered cheap.  Although, in WINN's case even this is debatable as the company has shown very little, if any, growth as far as we can tell since 2002.

($mln)                   Sales                      GP                          SG&A                    GP-SG&A                 CapEx

2002                       $7,759                   $2,179   '               $1,854                   $325                       $85

2003                       $7,577                   $2,208                   $1,962                   $246                       $177

2004                       $7,362                   $2,001                   $1,981                   $20                         $204

2005                       $6,945                   $1,813                   $1,929                   $(115)                     $112

2006                       $7,133                   $1,851                   $1,991                   $(140)                     $31

2007                       $7,201                   $1,936                   $1,964                   $(28)                      $92

2008                       $7,281                   $1,984                   $1,960                   $24                         $218

2009                       $7,367                   $2,098                   $2,035                   $64                         $217

2010E                    $7,163                     $2,027                   $2,006                   $21                         $200

CAGR                         1.0%                    -0.9%                 +1.0%                  -28.8%                    $148 average

Now, please understand that the numbers in the chart above may not be perfectly comparable as the company closed a lot of stores and reorganized in the 2005-2007 years.  However, the numbers presented above are from the company's documents and are close enough to get my point across: which is that there has been very little growth in sales and profits (on a relatively comparable store base) in the last eight years so why does this company deserve a premium multiple.  We don't think they do.

Company Adj. EBITDA Guidance:              $140mln (WINN's latest guidance: "low-end of $140-$160mln)

Less est. FY2010 Interest Exp Net:           $(5.0)mln (2x first half interest exp.)

Less est. FY2010 Cash Taxes:                 $(0.0)mln (WINN is not a cash taxpayer currently-big NOLs)

Less est. FY2010 CapEx:                         $(100.0)mln (Our post-remodel program estimate)

FY2010 Cash accruing to Shareholders:     $(35.0)mln

Now then, stepping back to the Capex question, a little more detail is in order.  Since 2002, WINN's average annual CapEx has been around $148mln (see the far-right column in the chart above).  If we use this number instead of $75mln then our Cash Earnings number drops to $(13.0)mln.  Not so great right.  OK, OK, we are not sure if all of the CapEx numbers in the above chart, which were in the company's documents, are comparable as some numbers may have been on a larger store base.  OK, let's split the difference and call it $112mln.  This brings the cash earnings number to $23mln (ahhh, finally a positive number-we can calculate a multiple!).  Based on $23mln in cash earnings, the stock is trading at 21.5x.  OK, OK, $112mln may still be a little high so let's make it $100mln in post-remodel program CapEx which brings us to a cash earnings number of $35mln which would put WINN's multiple closer to 14.2x.

The final point we would like to make on the valuation topic is that using the full $155mln in cash as part of the valuation is, in our humble opinion, very aggressive in light of the fact that based on the company's own guidance, they will likely burn through $65mln of that cash for all of FY 2010 which would imply a FY 2H cash burn of around $32.5mln putting the year-end cash balance at something like $123mln.  As a check, WINN's FY2009 YE cash balance was $183mln and after the F2Q FY 2010 it was $155mln for a net cash burn of $28mln which is about half of the $65mln in cash burn that we calculated... go figure.  Assuming the company doesn't significantly slow its remodeling program or show significant improvement in earnings, then the cash balance will shrink by another $65mln next year and the following and so on and so forth.  So, let's assume that after next year, WINN decides to stop single-handedly supporting the supermarket remodeling contractors business in the Southeastern US.  Assuming no improvement in operations, their cash balance would be somewhere around $58mln ($123mln in FYE 2010 cash less FY 2011 cash burn of $65mln = FYE 2011 cash of $58mln).  Let's also assume that steady state CapEx is $100mln as we discussed above (BTW according to the company's 2009 10-K WINN originally planned to spend $220mln in FY2010 total CapEx, $130mln of which was budgeted for remodels, which means that the remainder of $90mln wasn't for remodels-pretty close to our $100mln number).   This would put WINN's enterprise value at around $593mln which would value the company at a cash earnings multiple of around 17x assuming $35mln in cash earnings.  In our opinion, this is not a cheap valuation for a no-growth capital eating supermarket.  The last point we would like to make on this topic is that using a "maintenance capex" number for a supermarket is probably a bit aggressive simply because supermarkets have to keep re-investing their capital into remodels, whether major or minor, to remain competitive.  If they don't, then you eventually start to see it in the form of deteriorating performance.  This is especially true for WINN which must compete with the likes of Publix and Wal-Mart.

WINN has provided a very poor, well negative, return on capital employed

This fact can be displayed in many ways.  We will look at the effectiveness of capital spend.  Since 2002, WINN has spent a total $1.3bln (including full year FY 2010) in CapEx.  In that time frame, the company has generated a cumulative total of NEGATIVE $7mln in cash earnings.  Since 2006, cumulatively the company has spent a total of $727mln and generated a cumulative total of NEGATIVE $224mln in cash earnings.  In FY 2009, WINN spent a total of $217mln in CapEx which will, based on the company's guidance result in Adj. EBITDA of $140mln in FY 2010 vs $164mln in FY 2009; a 15% decline.  Any way you slice it, the company should re-think the way they are spending shareholder's money.

WINN's top line growth has been, and continues to be, anemic to negative

I touched on this in the first section so I won't spend a lot of time here, but since 2002, WINN hasn't generated any sales growth.  Yes, I know, they closed stores...  Well, that's simply a manifestation of management's poor allocation of capital.  Regardless, sales per square foot (assuming 46K sf/store and 520 stores) went from $324/sf in 2002 to $308/sf as of the end of FY 2009.  This trend appears to be continuing.  In WINN's most recent quarter, net sales declined by 2.3% in the quarter and 1.5% in the first half of FY 2010.  Identical store sales declined by 2.9% in the quarter and 2.3% in the first half even with the 5% sales lift from the company's offensive remodels.

The performance of WINN's offensive remodels is deteriorating

The following speaks for itself.

• From the WINN 2Q FY 2008 Earnings Release: "As of the end of the second quarter of fiscal 2008, the Company's 24 offensive remodeled stores had experienced a 12% weighted average sales lift after the grand re-opening phase. The sales lift in the offensive remodels resulted from increases in transaction count and basket size of 5.2% and 6.8%, respectively. Sales lift is calculated by comparing the store's sales following the completion of the grand re-opening phase to the store's sales in the prior-year comparable period." AND "Adjusted EBITDA was $41.1 million for the 28 weeks ended January 9, 2008".
• From the WINN 2Q FY 2009 Earnings Release: "For the first half of fiscal 2009, the Company's first year offensive remodeled stores had a 9.6% weighted average sales increase compared to the same period in the prior fiscal year, excluding the grand re-opening phase. This sales increase in the first-year offensive remodels resulted from increases in transaction count and basket size of 3.3% and 6.1%, respectively." AND "Adjusted EBITDA for the 28 weeks ended January 7, 2009 was $62.5 million".
• From the WINN 2Q FY 2010 Earnings Release: "The Company's 52 offensive remodeled stores that are still within their first year of operation, had a 5.8% weighted average sales increase compared to the same period in the prior fiscal year, excluding the grand re-opening phase." AND "Adjusted EBITDA for the 28 weeks was $53.3 million compared to $62.5 million in Adjusted EBITDA in the prior year period. Adjusted EBITDA for the 28 weeks of fiscal 2009 included a benefit of approximately $4.4 million due to storm-related sales net of storm-related inventory losses and other costs."

Mid single digit sales lifts from remodels, in our experience, is relatively poor performance as most remodels that we've seen generate sales lifts in the double digits.  It's interesting that we recently saw a reduction in FY 2010 CapEx spending guidance from $220mln to $200mln.  Maybe WINN's management is finally getting smart or they are simply seeing that the low hanging fruit as far as store remodels has been picked.

WINN has been reducing expectations

7/22/2009 - FY 2010 Adj. EBITDA - Initial guidance of $170-$180mln

10/26/2009 - FY 2010 Adj. EBITDA - Guidance reduced to $140-$160mln

2/16/2010 - FY 2010 Adj. EBITDA - Guidance reduced to "low end of guidance range" of $140-$160mln

5/2010 - FY 2010 Adj. EBITDA - Guidance reduced to...?

Other sundry items

• WINN recently announced that it will be distributing 6.5mln shares which are held in reserve to settle pre-petition bankruptcy claims to claimholders under its plan of reorganization. These shares are already included in the share count and thus won't result in any dilution. However, the shares will be distributed to many unnatural holders such as landlords, vendors, suppliers, and other unsecured creditors. This distribution will happen sometime after April 2010. Given that the share recipients are not natural holders of WINN, there could be a lot of selling pressure on WINN shares to the extent these shares come for sale on the open market.
• One of the main reasons WINN's 2Q FY 2010 wasn't worse was because they cut back on payroll. While this produced immediate benefits to the bottom line, it could come back to bite them if customer service is negatively impacted.

Risks

• WINN starts to show improvement in sales, including total sales, identical store sales and remodels.
• WINN starts to show sustained margin improvement which leads to improvement in cash earnings.
• WINN significantly reduces their remodel program.
• Another company buys WINN.

Catalyst

• WINN continues to reduce guidance and eventually shareholders figure out that they are throwing away their money.
• Sizeable shares come for sale after the company distributes the 6.5mln reserve shares in April 2010.