After going public in early 2012, we profiled Midwestern grocery chain Roundy’s (click ticker for report: ). Earnings momentum has moved materially against the company, and as we predicted, the firm had to slash its enormous dividend payout. In a typical post-IPO period, management was optimistic about future prospects, and competition in the firm’s core Wisconsin market looked weak at best.
What CEO Bob Mariano didn’t see coming was that Wal-Mart (click ticker for report: ) would enter Wisconsin in a big way, Woodman’s would keep growing, and Roundy’s-owned Copps would be thrown into a major price war, crushing same-store sales and margins.
Our initial thesis included a stable, or even slightly declining core business, but not the 3.6% decline we saw in the most recent quarter. Average transaction size was down 0.7%, but a 3% decline in store traffic is really what hurt the company. The older Copps stores are having a tremendously difficult time competing with the newer Woodman’s and Wal-Marts of the world, and we think Whole Foods (click ticker report: ) could easily enter some of the state’s bigger markets where it lacks a presence like Appleton-Neenah-Oshkosh and Green Bay.
On the bright side, Roundy’s Illinois presence, Mariano’s, is doing a fantastic job of expanding in the Chicago area. We’ve long documented SuperValu (click ticker for report: ) owned Jewel’s and Safeway (click ticker for report: ) owned Dominick’s struggles to maintain customers in this highly-populated and profitable region. Mariano’s focus on providing a more upscale shopping experience at value prices has been highly successful, in our view, and we think the trend will continue.
The problem at Mariano’s is real estate. The company is obviously not flush with capital ($88 million in cash versus $688 million in long-term debt), so the company has been forced to accept some mediocre real estate (the relatively sparsely populated River East) whereas large competitors like Jewel and Dominick’s have prime real estate close to train lines in Chicago. This is changing with new stores such as a North-and-Clybourn location that will be opened, but the company remains dependent on driving accessibility rather than convenience.
So where does this all leave Roundy’s? In a tale of two companies, one good and one bad, we’d generally see favorable prospects for a spinoff. However, Mariano’s needs the cash flow from the other Roundy’s businesses to expand, so we do not think a spinoff is a very likely event. A break-up or full acquisition does make sense, in our view, and we think Kroger’s (click ticker for report: ) is the best suitor. The company has virtually no presence in the Chicago area and none in Wisconsin, and with it’s fairly well capitalized balance sheet and Roundy’s low price, a deal could work.
However, just because it’s the best suitor, doesn’t mean it’s a likely suitor. Willis-Stein Partners, a private equity firm that has owned most of Roundy’s for over a decade, looked for buyers for a few years and essentially found none. Obviously, during much of the time the broader economic conditions had been unfavorable, but we think Kroger might have done a deal if it thought Roundy’s was worth buying. The price may be more favorable now, but it’s clear, in our view, that industry fundamentals have deteriorated.
As for SuperValu, it looks like it could be acquired by Cerberus, and we doubt a new management group would want to take on the task of integrating a new business while it has to sort out its mess of a core business.
Without any likely suitors, we see the only near-term catalyst as business stabilization. We remain fans of the Mariano’s business, and we think it has a nice growth path ahead of it, but it continues to be just a small part of Roundy’s overall business. We won’t be adding shares of the grocer to the portfolio of our Best Ideas Newsletter anytime soon.