Ingles Markets: Big P gains
Looking for a defensive consumer stock offering a high return on equity and a modest dividend?
Would you be prepared to pay what appears to be a high price, while still having a significant margin of safety?
One stock that meets both of these criteria is Ingles Markets Inc. (IMKTA, Financial), a North Carolina-based company that operates approximately 200 regional supermarkets.
About the Inglés markets
At the end of fiscal 2020 (September 26), the company operated 197 supermarkets in six states, all located within 280 miles of its warehouse and distribution facilities near Asheville, North Carolina.
In its 10-K for 2020, management argued that it has two competitive advantages. First, that it regularly renovates and redesigns its stores to make them look and feel modern. Second, he has knowledge of the territory that helps him stay in tune with the preferences of consumers in the region.
It was first incorporated in 1965 and has been publicly traded since 1987. Although publicly traded, it remains controlled by the Ingle family. At the close of fiscal 2020, Robert P. Ingle II owned 29% of the Company’s Class A and Class B common shares and controlled 76% of its combined voting rights (Class B shares are not listed neither traded on an exchange).
He developed his activity with several tactics:
- Modernize its stores, as indicated.
- Focus on high growth, high margin products.
- Sale of local organic and homemade meal replacement programs.
In his 10-K, Ingles lists the risk factors that could affect his operations and financial condition. They include:
- Its geographic concentration in one area makes it “vulnerable to economic downturns, natural disasters and other adverse conditions or other catastrophic events in that region.”
- Wider economic conditions could hurt consumer spending, including discretionary spending.
- Because Ingle controls 76% of the voting shares, it is a company controlled under the Nasdaq market rules. This means that it is exempt from some of the governance policies of the exchange; the majority of directors do not need to be independent and the company does not need a nominating committee for candidate directors.
Like other companies in the supermarket industry, Ingles faces intense competition and narrow profit margins (at least until fiscal 2020):
Competition varies between company stores, depending on the size of the communities and proximity to other communities.
In addition to local and regional stores, the company also competes with national chains such as The Kroger Co. (KR, Financial) and Walmart Inc. (WMT, Financial).
A double-digit return on capital of 13.58% suggests that the company enjoys one or more competitive advantages.
As the various ratios on the table suggest, Ingles is operating with significant leverage. It certainly looks great when seen in a chart with cash and cash equivalents:
With an interest coverage ratio of 10.57, the company is generating more than enough operating income to cover its interest charges. And Ingles Markets reported:
“The Company estimates, based on its current operating results and financial condition, that its financial resources, including cash balances, existing line, short and long term funding that should be available and Internally generated funds, will be sufficient to meet planned capital spending and working capital requirements for the foreseeable future, including debt service requirements for additional borrowings. ”
According to data in its May 5 report on second quarter and first half results, the company is improving its exposure to debt:
- It reduced its interest expense from $ 22.1 million in the first half of last year to $ 12.6 million for the same period this year.
- It refinanced $ 155 million of its 5.75% debt with 10-year secured debt at 2.95% fixed rate.
- As of March 2020, it has paid off $ 250 million in 5.75% debt.
The Piotroski F-Score is high, indicating that the management is doing a good job; the Altman Z-Score is also relatively high, which suggests that the company is unlikely to have financial problems at least in the immediate future.
The table also shows that management actually invested the company’s capital because the return on invested capital of 15.37% is significantly higher than the weighted average cost of capital of 4.4%.
The company’s free cash flow, which has also flourished recently, is not shown in the table:
The free cash flow position suggests that the company can now grow further or increase returns to shareholders.
As we saw above, operating and net margins increased in 2020. The table also shows us that the return on equity is good; the following graph shows that it recorded an average ROE growth of 10% per year:
The growth lines are all positive. This graph shows how revenues have grown over the past decade:
Growth in average EBITDA was even stronger:
The growth in earnings per (diluted) share has been very impressive:
With EBITDA and earnings per share growing faster than revenues, we can assume that the company is becoming more and more efficient and effective in its operations.
This improvement is reflected in these annualized returns:
- Year 2021 to date: 49.02%
- One year: 48.95%
- Three years: 31.32%
- Five years: 11.56%
- 10 years: 15.28%
Total annual returns oscillate from one extreme to the other:
- 2017: – 28.07%
- 2018: – 21.33%
- 2019: 74.54%
- 2020: -10.21%
- Year 2021 to date: 48.24%
Dividends and share buybacks
As the following chart shows, management has not been too sure which way to go with its dividends per share:
And here’s what the dividend yield looks like relative to the stock price:
While management and the board of directors were able to go back and forth on dividend payments, they took decisive steps to reduce the number of Class A shares:
The share price has trended upward over the past decade, and more specifically since August 2018:
Some observers and the GF Value Line have concluded that Ingles is overvalued because its stock price has risen so much since last October:
Still, its price-to-earnings ratio of 5.71 is less than a third of the retail industry’s 18.59 median – defensive.
Rapid growth in EBITDA gave it a PEG ratio of just 0.71, well below the fair value mark of 1.00.
The discounted cash flow calculator, based on a strong predictability rating of four out of five stars, also concludes that it is undervalued, with a substantial margin of safety:
Overall, this seems like an undervalued stock, but investors should do their own research to determine if they agree.
The gurus have been net sellers for the past few quarters. Perhaps they saw the rise in the share price as an opportunity to take profit:
Ten of the gurus were in positions at Ingles at the end of his second term (March 31). The three most important positions were those of:
Mario gabelli(Businesses, Portfolio) of GAMCO Investors; he held 851,802 shares, representing 4.49% of Class A shares and 0.46% of his own portfolio. It reduced its position by 15.29% during the quarter.
Chuck royce(Trades, Portfolio) of Royce Investment Partners held 649,091 shares, new holdings for him.
Jim simons(Trades, Portfolio) ‘Renaissance Technologies held 199,558 shares after a reduction of 17.66%.
Yes, the stock price has skyrocketed over the past nine months, but Ingles Markets has one hallmark of a value stock: a substantial margin of safety. On the other hand, the second characteristic, having little debt or not at all, is lacking.
The company has built a successful niche for itself and the growth in free cash flow suggests that it is well positioned to grow the business or reward shareholders with a higher dividend or share buybacks (buybacks would be effective if investors could confirm for themselves that stocks are undervalued).
Value investors may be tempted by the safety margin, but will want to wait for the company to reduce its debt even further. Growth investors should consider whether the recent results are an anomaly or the start of a new positive trend. The dividend may seem attractive to income investors, but the cost of purchasing it can be prohibitive.