Winn-Dixie's Game Plan?

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If you've ever wondered what a troubled company looks like, look no further than grocer Winn-Dixie's (NYSE: WIN) fiscal 2004 second-quarter results. The company lost $79.5 million on sales of $3.6 billion. The stock fell 40% after the earnings release, the dividend was suspended, and the company's debt was downgraded to junk status by Standard & Poor. To top it off, numerous lawsuits have been filed against the company alleging fraud. Could these be the markings of an out-of-favor value investment?

There's no question the second quarter of fiscal 2004 was bad. Sales were down 6% from the same quarter a year ago. Gross margins, having held steady over the last year at around 30%, slipped three points to 27%, largely because of new pricing policies.

Operating and administrative expenses as a percentage of sales jumped from 26% in last year's second quarter, to 29% in the most recent quarter. This included a $36 million non-cash charge for asset impairment, and a $21 million non-cash reserve for worker's compensation insurance. Absent these (hopefully) one-time charges, operating and administrative expenses were actually down 2.8% from the prior year's quarter.

Yet, in many respects, the second quarter of fiscal 2004 was an improvement from the first quarter. Sales jumped 33% sequentially, though operating and administrative expenses were up 42%, including the impairment and insurance reserve. Cash from operations was up 14% to $20.7 million, thanks in part to a $53.5 million reduction in inventories. It's certainly not enough to generate free cash flow, but it's a move in the right direction. The company's cash conversion cycle remains under one month, and with last year's debt reduction, Winn-Dixie generated enough operating cash flow to finance interest payments.

Of course, marginal improvements are meaningless if Winn-Dixie can't find a competitive advantage as it faces down Wal-Mart (NYSE: WMT) and the rest of the grocery industry. The company is committed to upgrading its image, and reducing operating expenses. At just under book value, and only 0.1 times sales, a successful turnaround could make this price look cheap. I'm betting Winn-Dixie can pull it off, and the current price offers the chance at a nice return.

Does Winn-Dixie stand a chance in the face of Wal-Mart? Do you think Winn-Dixie is a win-win or lose-lose investment? Talk it over on the Winn-Dixie discussion board.

Fool contributor Chris Mallon tries to find value where others see junk, and he owns shares of Winn-Dixie through his private investment partnership.