Ingles: Undervalued Supermarket Chain At 6.7x P/E And 0.9x Price/Book (NASDAQ:IMKTA)

Steady Growth at 6.7x P/E, 7.5% FCF Yield, Great Geographical Locations

Ingles Markets (IMKTA) is an extremely cheap stock relative to its own history and also peers. It has a very low P/E on FY09/2021 estimates of 6.7x relative to the industry P/E of approximately 20x [comprising of companies and recognizable names such as Stop n Shop, Whole Foods, Kroger, Supervalu, Winn-Dixie, and Ralphs]. We are taking our valuations based on the next fiscal year, because this year is positively distorted due to the Covid-19 impact. Ingles’ FCF Yield is an attractive 7.5% on steady-state FY09/2021. These valuations show that this company is exceedingly undervalued in comparison to its peers and competition, and has robust cash flow to facilitate organic growth on its already well-established 198 supermarket chain in the Southeastern region, with great geographical locations such as Georgia, North and South Carolina. All their supermarkets operate in suburban areas and small towns, limiting inroads of other chains and potential competition from entering and taking away from their market share. These are extremely attractive selling points to be invested into Ingles for the medium-term, and the risk-reward is very favorable.

Recession-Resistant

Ingles is recession-resistant and is not prone to cyclicality, similar to the entire supermarket industry. No matter the weather conditions, or the condition of the economy, people will still frequent supermarkets for their grocery needs. This industry will see minimal economic impact from any recession. In the case of Covid-19, which was unique in that it was a health-related crisis, we actually saw upward spikes in sales and food inflation which resulted in a huge increase in EPS. The company saw a surge in community buying to stock up on groceries whenever there was panic related to Covid-19 – see Q2 results section.

Reducing Debt

The company’s main issue is its debt. But, over the last few fiscal years, Ingles has been working to deleverage its balance sheet, curtailing its capital expense yet maintaining the same number of stores. This is occurring with increasing FCF being generated. This year, being an odd one as mentioned earlier, will lead to greater FCF Yield of 19.5%; but we project on a steady-state FY21, that the yield will drop to a more reliable 7.5% – a solid number, nevertheless.

Revenue and EPS CAGR

The company has a revenue and EPS CAGR of 2.6% and 13% over the last decade, suggesting Ingles to be a growth company. Since EPS has grown by a large amount YoY over the last decade, a more recent 5-year CAGR [2015-2019] for EPS growth of 5.7% is considered more appropriate. This shows that Ingles’ growth is steady, and in-line with the overall industry.

Supermarkets generally exhibit conservative growth rates and are generally steady throughout the year because of the nature of the business [what supermarkets sell are considered essential goods to consumers]. Sales CAGR for US supermarket chains, according to Statista data for the last decade has been 2.9%. Ingles has been relatively in-line with trends taking place over the widespread industry, when it comes to this average sales growth figure.

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Overall, Ingles is trading at a bargain, and very few other supermarkets are trading at as low a P/E as Ingles. The company has deleveraged its B/S and is looking to be more prudent with CapEx. The supermarket will see stellar earnings growth this fiscal year, but on a normal year FY21 the dust should begin to settle. We project healthy earnings, and as people start to look beyond Covid-19 and to 2021, the stock price should rally.

Price Target & Valuation

We have given Ingles a valuation based on our EPS of $5.32 on FY09/2021e and a conservative P/E estimate of 9.7x. Multiplying our EPS of $5.32 with our P/E of 9.7x, we arrive at our price target of $50.60 which represents 43% upside. We think our $50.60 price target is very fair and would point out that the stock’s previous high was $54.62, and the stock has traded close to $50 thrice in the last 5 years.

Source: Google

However, in the medium-term [2-3 years outlook], we think the stock has much more upside. Looking at Bloomberg data for Ingles’ P/E average over the last 3-years, it appears the average P/E for the stock has been around 12.0x. To calculate average P/E, one should not include P/E multiple values below 8.0x which occurred after March 2020, when earnings per share flew off the roof and hit record highs as a result of the pandemic. As a result, the average P/E was 12.0x.

Source: Bloomberg Terminal

Going a step further, we were able to do a relative valuation of Ingles to its peer group that all operate in the Eastern United States and are of similar market cap sizes. We found four companies that are close comparison to Ingles, and here are their 3-year average P/E multiple:

As you can see from above, all these companies have been trading more expensively than Ingles’ P/E of 12.0x. Our medium-term [2-3 years] price target of $63.84, on a P/E of 12x [multiplied with our previous EPS estimate for FY21 of $5.32] leads to an upside of 80%, implying favorable risk-reward.

Strong Cash Increase in 2020, Favorable debt reductions

Cash on the B/S increased from $42.1 million at year-end September 2019, to $152.1 million in June 2020, constituting a 261% increase in cash in the span of three quarters. Their net debt, as a result, decreased in three quarters from $810.1 million to $667.1 million. Long-term debt, a major concern on this company’s balance sheet reduced by $189.3 million, from $839.6 million to $650.3 million, or a -22.5% drop. These are all encouraging signs pointing to the fact that Ingles continues to focus on deleveraging its balance sheet, and simultaneously increase their cash reserves.

Healthy Free Cash Flow Generation

Ingles Markets has an FCF Yield on FY19 actuals of 6.9%, which is very healthy for a company who is generally focused on CapEx to cater to organic growth. This FCF Yield is expected, on our FY21e and FY22e to be 7.5% and 8.5%, respectively. Our figure for the FY20 is disproportionately high because of Covid-19 and falls back to 7.5% on our steady-state level in the following year FY21. A 7.5% yield is healthy and robust and will allow Ingles to successfully reinvest in its operations, increase store count, and help payback outstanding debt.

Ingles: Niche strategy of operating in small markets

Ingles is a leading supermarket chain in the southeast United States, operating 198 supermarkets in North Carolina (73), Georgia (66), South Carolina (36), Tennessee (21), Virginia (1) and Alabama (1). The company’s strategy is to locate its supermarkets primarily in suburban areas, small towns and neighborhood shopping centers. This provides a ‘moat’ against the company’s many competitors, as the market in which they are operating in is very fragmented. Their strategy encompasses selling high-growth, high-margin products including perishables, non-food and food items. The items they sell are sorted into the following categories, and in brackets we have included whether inroads of online competition [like Amazon] is present or not:

1. Their grocery category includes grocery, dairy and frozen foods (minimal online competition). Grocery in FY09/2018 and FY09/2019 is 35.5% and 35.4%, respectively (highest division of sales).
2. The non-foods category includes alcoholic beverages, tobacco, pharmacy, and health/beauty/cosmetic products. (online competition)
3. The perishables category includes meat, produce, deli and bakery. (minimal online competition)

Source: 10-K

Retail comparable sales excluding gasoline increased 3.9% during fiscal 2019 compared with 2018. The number of transactions (excluding gasoline) increased 0.9% while the average transaction size (excluding gasoline) increased by 2.8%. – Annual Report.

Below, is an Ingles supermarket in Asheville, NC – a state where Ingles has the most supermarkets locations:

Ingles in Asheville, NC by Charlotte Observer

If you’ve spent time in the western part of the state, you’ve probably seen or shopped at Ingles, which is headquartered in Black Mountain, just outside Asheville, where founder Robert Ingle opened his first store in 1963. The company went public in 1987 and is now one of the biggest companies in North Carolina, according to an article, albeit slightly dated but relevant, by the Charlotte Observer.

72% Real Estate Value and 0.9x Price-to-Book

Out of the 198 supermarkets, Ingles owns outright 162 supermarkets which either are free-standing stores or are the anchor tenant in an owned shopping center. This implies significant real estate value and makes this company attractive from an outsider’s view given the hidden asset value. The company also owns 21 undeveloped sites suitable for a free-standing store or development by the company or a third party.

The stated book value per share is $37.71, which means the stock is trading at just 0.9 price-to-book. Please note that this $37.71 is a tangible book value per share value [the company has negligible goodwill/intangibles].

72% of Ingles total assets are backed by real-estate holdings

[PPE divided by total assets]. Real estate can be used as collateral for indebtedness and can be sold to reduce indebtedness.

While we don’t have an exact marked-to-market real estate value [given company disclosures], but we would not be surprised if the present-day value may be as high as 2x the stated book value. This shows a more accurate picture of the worth of Ingles’ real estate. In our opinion, the company has understated their book value figure because they have not taken into account land appreciation. We looked through their Annual Report footnotes and they have not disclosed any updated marked-to-market real estate value.

Hence, we have reason to believe that their land value would have likely appreciated significantly since its historical date of purchase. It is important to note that the majority of Ingles’ land and owned properties are in very attractive and high appreciation real estate markets such as North Carolina, South Carolina, and Georgia. The company has been using the straight-line method of depreciation, with their buildings being depreciated over 30 years. While this seems reasonable, building real estate values have also likely appreciated significantly over time especially in Ingles’ location.

June Quarter: Record EPS and Revenue Growth

Source: Bloomberg Terminal

The 3Q ended June saw record earnings for Ingles. This was because of the surge in consumer demand for groceries, non-foods, perishables, etc. during the Covid-19 period. Consumers were making sure to be in a well-stocked position to be well-prepared in case of a potential Covid-19 wave. People went to supermarkets and hoarded on items, creating spikes in sales for Ingles which would otherwise have shown a normal growth rate of ~2-3% in the same year ago quarter. As you can see in the cases graph below for the US [taken from worldometer.com], there is a surge of Covid-19 cases into the last 2-weeks of June which led to Ingles’ strong quarterly results.

In the quarter ended June, Ingles saw a YoY increase in EPS of 167% and revenues of 12%. Because of the continuing increase in Covid-19 through July and August, as seen above, we expect year-end numbers for the September quarter to be rock solid as well. These quarterly numbers will lead to a robust year-end EPS estimate of $7.22 and revenue estimate of $4.5 million for the FY09/2020. This is again, a direct result of the coronavirus surge in buying.

Projections: 4Q, 2020 and next year 2021

We expect 4Q guidance, just as the previous quarter results, to be just as encouraging in terms of revenue and EPS, with both expected to yield record YoY comparison to the same quarter in prior years. Given our projections, we project annual sales growth to be +8.3% [versus a normal 2.6% annual growth rate] and an annual EPS jump to +79.4% [versus a normal 5.7% annual growth rate] for the fiscal year ended 09/2020.

In the FY09/2021, things will simmer down as the pandemic begins to ease in the US. However, Ingles’ sales will still be stable with margins starting to adjust and look more realistic on a normal year. EPS will fall as a result from FY20 highs [our EPS numbers for FY19/FY20e/FY21e are $4.03/$7.23/$5.32], but then again, the subsequent FY21 is the year investors will be focusing on and not so much on FY20 and Covid-19, because today’s results are more of an anomaly and don’t reflect the true worth of Ingles’ operations. Ingles’ stock price is down YTD in 2020, suggesting investors are not focused on this year’s huge jump in earnings, but rather on a more normal FY09/2021.

Supermarket Industry: Amazon to make limited headway

When it comes to supermarkets, people still think that Amazon and its widespread ecommerce influence will make inroads and have a detrimental impact. Although Amazon has expanded to brick-and-mortar with Whole Foods [acquired in 2017] and innovative supermarket concepts like “Go Markets”, we will be focusing solely on their online business and its impact on the supermarket industry.

Despite reservations, we are firm in our view that ecommerce players still don’t have what it takes to compete against supermarket chains such as Ingles. First, Ingles has a unique edge because it sells grocery and fresh items [35% of net sales] and perishable goods [27% of net sales] to its customers, representing 62% of total retail in all – Amazon’s online retail for the most part simply cannot provide provisions for these types of items through packaged shipping and distribution. The only segment of goods that Amazon’s online division has started to gain market share in is the non-food [23% of Ingles’ net sales] segment. Given below is a breakdown of each segment and total retail, along with a description of each food category:

Source: 10-K

Supermarket Industry: People prefer the Supermarket experience more

The experience counts: People want to go to a supermarket for the experience. Consumers want to be able to see items in person and browse isles and be able to discover new grocery foods to buy. This experience, which to many is very enjoyable, is not available online. Online shopping for small ticket necessities might occur, but rarely will one have the experience of bulk shopping, and in the process of discovering new items, which happens regularly in supermarkets in the US. Ingles need not worry, therefore, about online shopping taking away too much from sales in the longer term.

Furthermore, according to research conducted by Rabobank International, online grocery sales, spurred by consumer stay-at-home habits, is projected to reach 6.4% of total grocery sales by the end of 2021, from 3.1% in 2019. Depending on several factors, online grocery sales could represent only 4.8% to 9.1% of total grocery sales by the end of 2021.

When asked how their online grocery shopping will change once the pandemic is over, 10% of baby boomers said they will buy more groceries online, which compared to 35% for Generation X, 40% for millennials and 34% for Generation Z. The percentages for buying less groceries online once the pandemic subsides were 20% for baby boomers, 10% for Generation X, 16% for millennials and 22% for Generation Z.

“In other words, older consumers really don’t want to shop for groceries online,” the Rabobank report said. “It literally took a pandemic to get them to start ordering groceries online. It would make sense, therefore, that they are harder to retain once the crisis is over.”

Getting consumers to create a login and complete their first order is the biggest hurdle for growing the online grocery business, according to Rabobank.

Food inflation

Groceries were 4.5% more expensive in June 2020 than they were in February 2020, the month before the coronavirus pandemic was declared a national emergency in the United States. And the prices of some items rose more than twice as much which helped Ingles’ margins.

Population Growth

Source: U.S. Census Bureau

The population in Georgia [66 supermarkets], North Carolina [73 supermarkets] and South Carolina [36 supermarkets] has been growing because of increasing economic opportunity and improving standards of living in both states. This will benefit Ingles, as it will have a broader customer base to improve top line. An almost 10-year census results [2010-2019] yielded a 9.3%, 10%, and 11.3% growth in population for Georgia, North Carolina, and South Carolina respectively, against a comparative population increase of only 6.3% for the US in the same time period.

Growing Economy of Georgia, North Carolina, and South Carolina

GDP by State [Source: wikipedia ]

GDP of Georgia [66 supermarkets], North Carolina [73 supermarkets] and South Carolina [36 supermarkets] is 625 billion / 596 billion / 249 billion. Georgia, North Carolina, and South Carolina GDP rank amongst all US states: 9^th / 12^th/ 26^th and average GDP per capita is $58,896 / $56,862 / $48,547.

Corporate Philosophy: Equality, Diversity, Inclusion

Its corporate philosophy is described in three words: Equality, Diversity and Inclusion. Ingles Markets are so much more than a grocery store. They are made up of associates, customers, and vendors. They believe that each individual is as unique and different as the next individual, but their differences are what makes them better, stronger, and unified. Ingles Markets supports and encourages equality, diversity, and inclusion throughout their Corporate Office, Distribution Center, Retail Stores, and within each community they are located in.

They believe that they can play a bigger role to help fight racism by enhancing their training and awareness programs for all their associates, face their emotions, understand their biases, and open their hearts. They value people with different backgrounds, different races, and different abilities to stand together as one community.

Code of Ethics: High Quality & Standards

Ingles Markets follows a strict Code of Ethics for their CEO and Senior Financial Officers to help their company maintain the highest standards of conduct by reminding the CEO and the Senior Financial Officers of their responsibilities to Ingles, each other, customers and investors of Ingles, governmental authorities and the general public. The Management believes that because their business depends on its reputation and the reputation of their financial records, the Code goes beyond the requirements of law to maintain the highest possible standards of integrity.

The company describes the Purpose of The Code thus:

“The purpose of this Code is to set standards for our CEO and our senior financial officers as are reasonably necessary to promote (I) honest and ethical conduct; (II) full, fair, accurate, timely and understandable disclosure in the reports and documents that we file with or submit to the Securities and Exchange Commission and in other public communications; and (NASDAQ:III) compliance with applicable governmental laws, rules and regulations.”

Catalysts

Margins

Fixed cost leveraging on greater sales volume will lead to a benefit and expansion in margins.

Deleveraging the Balance Sheet

The company has been reducing their debt, which has been their major issue from a financial standpoint.

FCF Yield

On FY21e, we estimate FCF Yield to be an attractive 7.5%.

Recession-Resistant

The supermarket industry is recession-resistant, indicating that even if there are downturns in the economy people will still continue buying grocery and food items.

Favor the traditional ‘supermarket experience’

We believe that people will not pay much attention to growing online ecommerce and that instead, they will still visit supermarkets for the experience aspect. The experience is enjoyable and can’t be found online. This will benefit Ingles, as most people who visit a supermarket end up buying in bulk.

Buyout

Even though in the next section we have pointed that the owner [possessing a majority stake of the business of 60%] might be reluctant to sell, there is clearly a lot of value in the shares of Ingles’ for any interested buyer. Robert P. Ingle II, is currently the CEO of Ingles and son of Robert Ingle [founder of Ingles Supermarkets]. While we have no indication that management is looking to sell the company in a rapidly consolidating industry, it is our firm belief that there would be a lot of interest at much higher prices should a takeover ever occur.

Risks

Two classes of shares: Owners may not sell the company

Ingles has two classes of shares; class A and class B. It is clear that owner Robert P. Ingle II, who owns 60% of the total shares outstanding, controls a majority vote. This can be a risk factor, but that doesn’t mean the business is not a good investment. A ton of companies have two classes of shares, such as Warren Buffett’s Berkshire Hathaway, which is one of the best performers all-time. All these stocks are still great investments.

Online making in-roads

Online, although has shown minimal growth in the supermarkets industry, can always have a greater impact and take a share of the pie down the road. You never know what disruptive trend could make itself known in the next 5 to 10 years which could adversely impact supermarket’s business appeal towards consumers.

Slowing Growth in Revenue & EPS, Margin Pressure

EPS and revenue growth are predominantly stable in this sort of industry. However, there stands to be the risk that these numbers fluctuate due to trends in the industry. If margins come down, then earnings will take a hit.

Conclusion

Ingles is a steady-growth company with a revenue and EPS CAGR of 2.6% and 5.7%, respectively. The company, however, is highly undervalued against the industry average, with a P/E of 6.7x. The stock is dirt cheap; we have set our ST price target for $50.60 [43% upside] and LT price target for $63.84 [80% upside]. Ingles also has significant amount of real estate valued at 72% of the entire company’s total assets with a BVPS of $37.71, or 0.9x price-to-book, and we think the land value has nearly doubled since its historical date of acquisition. These valuations and selling points, make Ingles an attractive stock to be invested in.

You can download our 10+ page research report: Ingles Report. This report has our detailed analysis on Ingles, inclusive of a financial model: IS/BS/CF forecasts, rigorous ratio analysis, and price target which is justified by the model. A preview of the entire report [with model after text] can be seen below:

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.