Ahold Delhaize: A High Single Digit Free Cash Flow Yield From A Defensive Stock (Rating Upgrade)

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European grocery retailers like Ahold Delhaize and Carrefour have underperformed US peers such as Kroger in the past year.The underperformance has resulted in higher free cash flow yields at Ahold ...

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HispanolisticIntroduction I previously covered Ahold Delhaize (OTCQX:ADRNY) back in late 2021 where I argued that sustaining the robust operating margin would be key to bridging the valuation gap with US peers, with covered call selling an excellent way to position in the shares. Over the past year, European grocery retailers such as Ahold Delhaize and Carrefour (OTCPK:CRRFY) have underperformed US peers such as Kroger (KR): Ahold Delhaize, Carrefour and Kroger over the past year (Seeking Alpha)This has resulted in European peers trading at higher free cash flow yields, which I reckon creates a buying opportunity in stocks such as Ahold Delhaize, notwithstanding the expectation for marginally lower free cash flow across the grocery sector in 2024. Company Overview You can access all Ahold Delhaize investor materials here. Operating a variety of store brands, Ahold Delhaize derived 61.5% of its 2023 sales from the United States, with Europe accounting for 38.5% of the company's topline:   Segment division of sales (Ahold Delhaize 2023 Annual Report)From a profitability perspective, the importance of US sales is even greater, accounting for 69.5% of underlying operating income, compared to a 30.5% contribution from Europe: Segment reporting (Ahold Delhaize 2023 Annual Report)Looking at the data above, we observe that sales growth was higher in the United States over the 2020-2022 period, with growth shifting to Europe in 2023 - comparable sales in Europe grew 6.5% in 2023 versus just 1.8% in the United States. Operational Overview In 2023, Ahold Delhaize grew sales 1.9% Y/Y (2022: +15.1% helped by inflation and foreign exchange). Underlying operating income was down by 3.3% in 2023, impacted by a 0.2% Y/Y drop to 4.1% in the operating income margin. Helped by a €1 billion share buyback in 2023, underlying income per share was only 0.4% lower Y/Y at €2.54/share: Operating result highlights (Ahold Delhaize 2023 Annual Report)Free cash flow was €2.4 billion in 2023 (2022: €2.2 billion), boosted by lower capex spending. 2024 Outlook Looking ahead, Ahold Delhaize expects flat results in 2024, with a similar operating margin, earnings per share, and a marginally lower free cash flow of €2.3 billion: Ahold Delhaize 2024 Outlook (Ahold Delhaize 2023 Annual Report)Capital Structure Ahold Delhaize continues to employ moderate leverage in its funding profile, with net debt of €14.3 billion at the end of 2023, down 1% Y/Y, relative to a €26.4 billion market capitalization. Furthermore, €10.5 billion of the debt is related to lease liabilities, further limiting the financial impact on the company. The average interest cost of the debt was 5.9% in 2023 (2022: 6.4%), helped by lower coupon issues in euros. The company spent €1 billion on share buybacks in 2023, with a similar allocation planned for 2024 as well. Comparison with Carrefour Compared with Carrefour, Ahold Delhaize delivered weaker sales growth and lower free cash flows in 2023, offset by a higher operating margin but also larger leverage:   Metric\\Company Ahold Delhaize Carrefour   Free cash flow yield to market capitalization, March 2024 9.1% 14.6%   Sales growth 2023 1.9% 10.4%   Operating margin % (underlying) 4.1% 2.7%   Net debt as a % of enterprise value 35% 19%   Click to enlarge Source: Author calculations based on company disclosures. While Carrefour benefitted from lower taxes, restructuring and changes in working capital in its 2023 free cash flow, the difference relative to Ahold Delhaize in free cash flow yield is quite significant. As such, I consider Carrefour to be a better pick at the moment, especially if you don't mind the emerging market exposure of the French retailer. Comparison with Kroger Compared with Kroger, Ahold Delhaize outperforms on both free cash flow yield, sales growth, margins, offset by higher leverage:   Metric\\Company Ahold Delhaize Kroger   Free cash flow yield to market capitalization, March 2024 9.1% 7.8%   Sales growth 2023 1.9% 1.2%   Operating margin % (underlying) 4.1% 3.3%   Net debt as a % of enterprise value 35% 21%   Click to enlarge Source: Author calculations based on company disclosures. Overall, while Ahold Delhaize's sales grew faster than Kroger due to the former's European exposure, Ahold Delhaize appears to be the better pick of the two companies, boasting a stronger free cash flow yield and higher margins. Risks The main risk facing Ahold Delhaize is erosion of its dominant operating margin position. In 2023, it already dropped from 4.3% to 4.1%, but remains higher compared to peers such as Carrefour and Kroger. As such, achieving a result on par with 2023 or higher will be vital for the stock to maintain healthy free cash flow generation. Conclusion Ahold Delhaize results were little changed in 2023, with more of the same expected for 2024. Stability is good for defensive stocks and Ahold Delhaize surely checks all the marks. The key thing to watch will be whether the company manages to arrest the drop in operating margins, a key differentiator relative to peers. The comparison with competitors such as Carrefour and Kroger brought mixed results, with Ahold Delhaize appearing cheaper relative to Kroger but more expensive compared with Carrefour. Nevertheless, I reckon Ahold Delhaize will continue to outperform in its key US market, ultimately achieving a higher valuation. For investors who do not mind a larger emerging markets exposure, Carrefour may well be the superior pick. With stock indices at all time highs, it may be advisable to consider defensive stocks such as Ahold Delhaize. I expect the company to return to free cash flow growth starting in 2025, which will complement its already attractive free cash flow yield. As a result, I rate the shares a buy. Thank you for reading.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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