Village Super Market: Margin Concerns Highlighted In Recent Quarter

seekingalpha07-09

Village Super Market operates 38 supermarkets, with a history of slow store network expansion.Profitability weighs on VLGEA, as long-term SG&A inflation and very notable SG&A increases in Q3 make for ...

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Quarter\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-07-09 22:22 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4703152-village-super-market-stock-vlgea-margin-concerns-recent-quarter-earnings><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Village Super Market operates 38 supermarkets, with a history of slow store network expansion.Profitability weighs on VLGEA, as long-term SG&A inflation and very notable SG&A increases in Q3 make for ...</p>\n\n<a href=\"https://seekingalpha.com/article/4703152-village-super-market-stock-vlgea-margin-concerns-recent-quarter-earnings\">Source 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Market：最近一个季度利润担忧凸显","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"WMT":1,"ACI":1,"KR":1,"IMKTA":1,"VLGEA":1},"content_text":"Village Super Market operates 38 supermarkets, with a history of slow store network expansion.Profitability weighs on VLGEA, as long-term SG&A inflation and very notable SG&A increases in Q3 make for a weak margin outlook in the thin-margin sector.The valuation seems attractive on the surface with the low overall risk level, but as I believe that better opportunities exist in the sector, I rate VLGEA stock at Hold.   hapabapa Village Super Market, Inc. (NASDAQ:VLGEA) operates supermarkets through the ShopRite, Fairway Markets, and Gourmet Garage brands in the U.S., with 38 total stores standing at the end of FY2023. The company has historically slowly grown out its store footprint in certain markets, including mainly New Jersey, New York, Pennsylvania, and Maryland. The stock has stayed near stable in the past decade despite the company growing out its retail network. On top, Village Super Market does pay out a stable dividend with a current yield of 3.97%.   Ten Year Stock Chart (Seeking Alpha) A Modestly Growing, Small Grocery Chain Village Super Market has achieved modest but overall stable revenue growth over the long term at a CAGR of 4.3% from FY2004 into trailing revenues of $2212 million as of Q3/FY2024 as a result of slow store network expansion and same-store sales growth. From the end of FY2019, the total store count has increased from 33 to 38, slightly more rapidly than previously as at the end of FY2011 there were 28 stores. Coupled with higher inflation raising FY2020 and FY2021 growth, the recent growth has been faster than usually, but should come down as at-home food inflation is slowing down into just a 1.0% rate year-over-year as of May 2024 in the United States. Yet, with the 38 current stores, the chain is a very small player in the sector. The recent store expansion has also required quite a good amount of capital, with $64.8 million spent on capital expenditures in FY2023 compared to D&A of just $35.7 million.   Author's Calculation Using TIKR Data The overall growth has been in line with industry peers such as Walmart (WMT), Kroger (KR), and Albertsons (ACI), as the variance in FY2021 and FY2022 is mainly related to a differing fiscal year period from the peers.   Author's Calculation Using TIKR Data Markets Didn’t Take Q3 Results Kindly Village Super Market reported its Q3/FY2023 results in early June, which investors didn’t take to kindly, as the stock declined -8%. The stock has also continued falling in the weeks following the results. In the quarter, same-store sales grew by 2.3% due to continued slight food inflation, a great 9% same-store digital sales growth, strong pharmacy sales and store remodeling attracting very slightly more customers – the quarter’s same-store revenue growth was in line with previous quarters, as Village Super Market has a year-to-date 2.2% growth in same-store sales after the quarter. The sales still continue to perform stably, and didn’t pose a reason for the stock’s decline. Instead, profitability took a large hit in Q3, being the likely reason for investors’ negative reception – prior quarters still showed robust margins, but in Q3 the operating margin fell by 0.8 percentage points year-over-year into 1.9%, being detrimental to earnings due to grocery chains’ typical thin margin profile. The gross margin was nearly stable year-over-year, but SG&A inflation pushed the earnings down. Village Super Market associated the SG&A increase to multiple factors, with SG&A scaling from 24.33% of sales a year ago into 25.19% of sales – 0.23 percentage points were related to higher labor costs and fringe benefits, 0.10 to external digital sales growth fees, 0.08 to increased store security, 0.07 to software licensing investments, and 0.06 to higher facility repairs and maintenance costs. Many of the factors behind the SG&A increase, notably wage inflation, external digital sales fees, and potentially increased store security, are likely to repeat again in at least the short term, but also over the long term with many of the expenses seeming necessary to continue generating healthy sales – I believe that the negative reaction was very well justified. SG&A Increases Have Been Faster Than Gross Profit Growth Over the long term, the margin trajectory has also been quite weak – the average margin has clearly seen deleverage during the past two decades, and although the margin increased extremely well in FY2023, the Q3 results could start the beginning of a series of declining margins back into the long-term trendline.   Author's Calculation Using TIKR Data Interestingly, contrary to what the operating margin history lets believe, Village Super Market’s gross margin has expanded well during the past decade from a gross margin of 27.3% in FY2015 into a current 28.6% gross margin with consistent increases – the reason behind the longer-term margin decline is continued SG&A increases beyond gross profit growth, which the Q3 result once again showed.   Author's Calculation Using TIKR Data The current trailing gross margin is above Walmart’s 24.5%, Kroger’s 23.0%, and Albertsons’ 28.4%, but yet, Village Super Market’s trailing operating margin of 2.8% trails all of the mentioned peers. Village Super Market’s smaller operations provide less space for operating leverage, leaving the margin much lower than larger chains’. In addition, the long-term and Q3 operating margin trajectory have been worse than the peers’, underlining a continued margin risk. I doubt that Village Super Market is able to source its products cheaper than the larger peers, and the better gross margin is likely a result of higher pricing, pushing down total sales volumes in a given store. Due to the company’s small position in the sector, it doesn’t seem likely that Village Super Market is able to raise the margin, especially given the Q3 result. The Absolute Stock Valuation Seems Cheap I constructed a discounted cash flow (\"DCF\") model to estimate a fair value for the stock. In the model, I estimate revenue growth to slow down into a perpetual 2.0% in the coming years with slow inflation and slower new store investments. Due to the Q3 margin pressure and the long-term margin trajectory, I believe that caution is needed in estimating Village Super Market’s margins going forward – I estimate the margin to slowly decrease into 1.8%, near the reported Q3 level of 1.9%. I estimate quite a poor cash flow conversion in FY2024 and FY2025, but a better conversion afterwards with slower investments. From FY2023 to FY2033, I estimate an average annual free cash flow of $25.7 million.   DCF Model (Author's Calculation) The estimates put Village Super Market’s fair value estimate at $36.01, 40% above the stock price at the time of writing – the stock seems to have an undervaluation despite the weak expected margins. Higher-than-estimated margins could also pose further upside for the stock, as a small change makes the stock’s value higher rapidly. CAPM A weighted average cost of capital of 7.08% is used in the DCF model. The used WACC is derived from a capital asset pricing model:   CAPM (Author's Calculation) In Q3, Village Super Market had $1.0 million in interest expenses, making the company’s interest rate 5.34% with the current amount of interest-bearing debt. I estimate a long-term debt-to-equity ratio of 15%. To estimate the cost of equity, I use the 10-year bond yield of 4.29% as the risk-free rate. The equity risk premium of 4.60% is Professor Aswath Damodaran’s estimate for the U.S., updated on the 5th of January. Seeking Alpha estimates Village Super Market’s beta at an incredibly low 0.21, but I instead use Aswath Damodaran’s grocery retailers’ industry beta estimate of 0.49 as it represents the company better in my opinion. With a liquidity premium of 1%, the cost of equity stands at 7.54% and the WACC at 7.08%. Peer Valuation Implies a Fairly Valued Stock Compared to many peers such as Kroger, Albertsons, and Ingles Markets (IMKTA), Village Super Market’s EV/EBITDA trades in line at a trailing 6.5 multiple – a peer comparison doesn’t show space for outsized returns. Walmart trades at a considerably higher EV/EBITDA of 15.8, but I believe that stock's differing financial profile justifies a gap in the valuation. I have also previously written on Walmart in a negative tone concerning the valuation.   Peer EV/EBITDA Comparison (Seeking Alpha) I believe that the multiple is still incredibly low, though – grocery chains carry a very low macroeconomic risk profile, making the stocks’ fair expected returns lower than the broad market’s. I have previously written bullish articles on Albertsons and Ingles Markets, as I believe that the sector has multiple attractive risk-to-reward investments given the low risks associated with the stocks. While Village Super Market’s valuation seems to have upside, I believe that some of the alternatives in the sector have a wider undervaluation unless Village Super Market can sustain higher margins than I currently anticipate though. Takeaway  Village Super Market has a history of stable, modest revenue growth with slow store expansion. The company’s margins show a considerably worse performance though, as long-term SG&A increases that have pressured the margin trajectory once again emerged in Q3, pressuring the stock. While the stock seems to be undervalued despite my conservative margin estimates, I believe that other stocks in the sector such as ACI and IMKTA show more upside. 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