Albertsons: Not Shopping Yet

Albertsons Companies (ACI) is returning as a publicly-listed company, as it has quite a turbulent past of course, including restructurings, acquisitions, followed by divestments, as private owners Cerberus were looking to sell shares for quite a while. Now the offering has finally taken pace after a previous attempt to go public in 2015 failed.

The company still has quite a few operational and financial challenges, yet modest valuations and a real boom brought on by Covid-19 create an interesting situation, and while I see some appeal, it is not convincing enough for me to start buying.

Quick Look At The Business

As discussed above, the corporate past is quite eventful including many deals and restructurings, but overall has not been a major winner for investors, nor has provided stability for other stakeholders in the firm. Fact of the matter is that the company still has challenges, in part because it operates so many chains and faces both very fierce online and offline competition. Nonetheless, management claims that following the 2015 merger with Safeway as well as additional restructuring and integration, Albertsons has regained a lot of competitiveness in the industry.

Ironically it is the Covid-19 crisis and the hoarding effect which might have opened the IPO window for the company here, as owners and management acted swiftly to try to go public again.

It is good to recognize for a moment the size and scope of the business as Albertsons has more than 2,200 stores across 34 states, divided over 20 banners as more than a quarter of a million employees serve more than 30 million customers each week. More streamlined operations and focus on the customer have paid off to some extent with identical sales coming in basically between flat and 3% in each of the quarters of 2018 and 2019, largely in line with the wider category.

The IPO, Valuation Discussions

The pricing process can easily be labeled somewhat of a disappointment. Initially the company and its underwriters were looking to sell 65.8 million shares in a range between $18 and $20 per share, in an offering which should raise $1.25 billion in gross proceeds. The final offering was scaled back in size and price, as now 50 million shares are offered at $16, reducing gross proceeds to $800 million. Very important to realize is that the shares being sold are not sold by the company, but benefit selling shareholders, and their willingness to accept a much lower price is quite telling.

The 479 million shares outstanding following the offering now represent a $7.7 billion equity value at the offer price. This represents less than half of the enterprise value – the company reported a net debt load of $8.2 billion by the end of 2019 – of $16 billion, although net debt has come down quite a bit from $11.6 billion in 2015 following the deal with Safeway. With shares down 2% near the end of trading on their opening day, this implies that the total valuation is approximately $150 million less than discussed above.

Actual operations have seen modest growth with sales having advanced from little less than $59 billion in 2015 towards $62.5 billion in 2019, although this hardly or does not even keep track of inflation of course. Margins are thin, but have generally improved from about half a billion to about a billion on an operating basis, and that is after adjusting for asset gain/losses.

These margins are typically lower than other peers as the situation looks challenging by all means. An $8.2 billion net debt load and $2.8 billion EBITDA number look reasonable with 3 times leverage, yet the earnings capacity is simply very limited, with D&A making up most of the EBITDA number.

The company might be able to benefit from some refinancing, and we could construct a preliminary income statement. Assuming a billion in EBIT in normalized earnings power and assuming 6% borrow rate at more than $8 billion in net debt, as well as a 20% tax rate, net earnings might come in around $400 million. Given the share count of 479 million, that works down to $0.80-0.85 per share, as some deleveraging and refinancing might allow this number to rise to a dollar, essentially valuing the shares at a market multiple.

Note that the fiscal year of 2019 ended late February, so it does not match the calendar year. For the first quarter, the company reported 47% identical sales growth in March, 21% in April and another 21% in May. On top of this spectacular growth (even compared to some peers), it is good to see net debt down to $6.7 billion, as that really allows for much lower interest expenses, certainly in combination with lower leverage ratios as well following a boost in EBITDA. With EBIT margins more or less tripling in the first quarter and sales up spectacularly, the first quarter looks very good. Assuming interest expenses fall from $500 million to $400 million following recent improvements, the earnings power of a dollar is already in reach, merely thanks to lower net debt, not accounting for higher earnings as a result of Covid-19 yet.

Keeping An Eye On

The risk factors are pretty clear. Immediate risk is that of leverage, although Covid-19 is a real blessing for the company ironically. The other is that of lackluster margins and the fact that the company faces a lot of competition. The past ownership and volatility are not helping in this respect, certainly not when the company has large investments to make and requires continuous change, but Albertsons has been doing something very good in recent times.

With leverage ratios, or at least net debt in relation to the enterprise value being higher than many peers, it is best to simply look at the enterprise value in relation to sales, suggesting the business is valued at 0.25 times based on 2019 sales. Some immediate competitors to think of include of course Kroger (KR) and Walmart (WMT). Kroger might actually be a good competitor, with $36 billion enterprise value and over $120 billion in annual sales, it works down to about 0.3 times sales, just above Albertsons’. Truth is that Albertsons has more leverage on a relative basis, less scale and slightly lower margins as well.

All in all, I am not very attracted to the business given its history, low margins and still above-average leverage, yet I do see reasonably modest valuations and a very good performance during Covid-19. While this extra earnings are of course not sustainable, they are quite substantial and could make a real difference in addressing leverage. This factor and the fact that pricing has been a bit soft do make that Albertsons deserves a place on the watch list for potential cheap valuations, yet not necessarily a very strong business.

Disclosure: I am/we are long KR. 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.

Source: Seeking Alpha

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