Grocery store chain Roundy’s (click ticker for report: ), which operates under several banners in Wisconsin, Minnesota, and Illinois, reported solid fourth quarter results late last week. Sales increased 1.4% year-over-year to $982 million, roughly in line with consensus expectations. Earnings weren’t as strong, falling 37% year-over-year to $0.19 per share—a figure that excludes the impact of a few one-time events.
The trend we saw at Roundy’s throughout 2012 continued in the fourth quarter: Chicago’s Mariano’s chain did fantastically well, “exceeding” sales and profit expectations while posting double digit same-store sales growth. On the other hand, the core business in Minnesota and Wisconsin continues to struggle, dragging total same-store sales down 2.1%. These markets, once underserved by Target (click ticker for report: ) and Wal-Mart (click ticker for report: ), are now being onslaught by new competition. Even more discouraging, in our view, was that the traffic at Roundy’s stores fell 3.5%.
Free cash flow was also disappointing, in our view, falling to $43.7 million during 2012, down from $115.5 million in 2011. Because the firm raised large amounts of capital in its February IPO, it was able to reduce its total debt load, which is down to $697 million. This will reduce the company’s interest expense going forward, and we hope the company uses free cash flow to continue to pay down debt. Unfortunately for shareholders, we think the company has put itself in a difficult place, committing to a $0.12 per share dividend. Assuming $0.48 per share in dividends for this year—a yield just shy 8% at current levels–we simply don’t think it is the best use of capital. The company is already at a huge disadvantage in the sense that it can’t compete in price wars with Target or Wal-Mart, so returning cash to shareholders when it could be using it to pay down debt and invest in Mariano’s while the core business declines seems like a poor choice of capital allocation, in our view. Income investors may be tempted by the high yield, but we prefer to focus on dividend growth investing, and Roundy’s dividend doesn’t look poised to rise, in our view.
Going forward, the firm’s guidance paints a picture of 2013 that leads us to believe it will be quite similar to 2012. Capital expenditures will total $63-$68 million, a slight increase from 2012, while sales are expected to grow 3%-4%, even though same-store sales are expected to fall 1.5%-0.5%. Adjusted earnings-per-share guidance of $0.88-$1.01 assumes some further margin deterioration and the company plans to open 5 new stores during the year. We like CEO Bob Mariano’s history as an operator, but Roundy’s has two businesses right now; one good and one bad. For the time being, we’ll be avoiding shares in the portfolio of our Best Ideas Newsletter.