6/17/10

Anyone have a view on the long term potential of a large cap grocer LBO?

SWY, KR, SVU. All trade at anemic ev/ebitda multiples. KR and SWY are levered less than 2x on a net debt to ebitda basis. Predictable cash flows. Majority of Walmart impact is already felt. Stocks are out of favor on deflation and their capital spending in 2005 - 2007 was aimed at looking more like whole foods - not what the consumer wants at the moment , but a cyclical problem.

Anyone see any lbo potential here? Outside of "you cant get 12bn of lbo financing today june 17th 2010" - im talking in general here - over the next few years.

Comments (9)

Best Response
6/17/10

They can't support too much leverage. Any growth needs to be supported by significant capex in new stores, local advertising spend etc. Growth in comparable stores that are over 2 years old is probably very limited and without extreme promotional spend, there won't be the type of growth necessary to support EBITDA growth over a 5 year period. Its very difficult to sustain organic growth without harming your margins. You can't rely on "new" product offerings the way a best buy would; there really is no exculsivity in product that can drive traffic in this space, especially not for a safeway, kroger etc. These businesses also rely on private label brands in detergents, shampoos etc. to boost profitability. They also help offset the margin pressure they get from the largest brands like P&G. Again, there is only so much private label product you can allocate shelf space too and only so many customers you can sell them to before your reach saturation.

A recent deal in this space for a regional grocery chain was done under 7.0x ebitda with leverage accounting for ~ 50% of that structure. It wasn't that credit was unnavailable, but to support the growth plan, you couldn't burden this thing with term debt. Even more so, the revolver would throw the multiples up wildly on a monthly basis as it was drawn for working capital needs. Any new store growth would also be financed partially by this revolver and when that happened, the multiples would start to look like any other LBO deal for the period.

Without the necessary leverage, the returns don't work. I also don't think they can support more than 4.5-5x leverage on a base case. Therefore its unlikely these businesses will be purchased for more than 8x/9x EBITDA in my opinion.

BTW, look at these busineeses on an EV/EBITDAR basis, the rent is a huge drag on EBITDA...

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In reply to MezzKet
6/17/10
MezzKet:

They can't support too much leverage. Any growth needs to be supported by significant capex in new stores, local advertising spend etc. Growth in comparable stores that are over 2 years old is probably very limited and without extreme promotional spend, there won't be the type of growth necessary to support EBITDA growth over a 5 year period. Its very difficult to sustain organic growth without harming your margins. You can't rely on "new" product offerings the way a best buy would; there really is no exculsivity in product that can drive traffic in this space, especially not for a safeway, kroger etc. These businesses also rely on private label brands in detergents, shampoos etc. to boost profitability. They also help offset the margin pressure they get from the largest brands like P&G. Again, there is only so much private label product you can allocate shelf space too and only so many customers you can sell them to before your reach saturation.

A recent deal in this space for a regional grocery chain was done under 7.0x ebitda with leverage accounting for ~ 50% of that structure. It wasn't that credit was unnavailable, but to support the growth plan, you couldn't burden this thing with term debt. Even more so, the revolver would throw the multiples up wildly on a monthly basis as it was drawn for working capital needs. Any new store growth would also be financed partially by this revolver and when that happened, the multiples would start to look like any other LBO deal for the period.

Without the necessary leverage, the returns don't work. I also don't think they can support more than 4.5-5x leverage on a base case. Therefore its unlikely these businesses will be purchased for more than 8x/9x EBITDA in my opinion.

BTW, look at these busineeses on an EV/EBITDAR basis, the rent is a huge drag on EBITDA...

that pretty much sums it up

In reply to MezzKet
6/17/10

MezzKet... Your posts are very insightful. +1

6/17/10

Yeah great answer. Haven't looked at the space but that all makes perfect sense.

6/17/10
6/19/10

EBIT margins are also usually below 5%...maintenance and growth capex big concern, great summary above

In reply to MezzKet
8/2/10
MezzKet:

They can't support too much leverage. Any growth needs to be supported by significant capex in new stores, local advertising spend etc. Growth in comparable stores that are over 2 years old is probably very limited and without extreme promotional spend, there won't be the type of growth necessary to support EBITDA growth over a 5 year period. Its very difficult to sustain organic growth without harming your margins. You can't rely on "new" product offerings the way a best buy would; there really is no exculsivity in product that can drive traffic in this space, especially not for a safeway, kroger etc. These businesses also rely on private label brands in detergents, shampoos etc. to boost profitability. They also help offset the margin pressure they get from the largest brands like P&G. Again, there is only so much private label product you can allocate shelf space too and only so many customers you can sell them to before your reach saturation.
than 8x/9x EBITDA in my opinion.

BTW, look at these busineeses on an EV/EBITDAR basis, the rent is a huge drag on EBITDA...

Whilst I agree with your post, I would add that growth stagnation in comparable store sales can be offset by stores openings. Hence, EBITDA expansion would depend on ROI from new stores openings.

8/3/10

Sure, pont taken. Its hard to justify and weigh ROI in the short run during a recession and maintaing liquidity. These things have such low cash flow conversion rates that they seldom risk jeopardizing cash flow for the prospect of another $2m in incremental EBITDA. With stagnation comes higher inventory losses on perishable items ie lower inventory turns and drag on cash flow - revolvers become even more essential. I'm not saying they wont pop open a store or two, but you wont see them go on a spending spree in a recession to offset comp store sales.

8/7/10

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