On This Grocer's Shopping List: Cash

Even with a logo and name that seem like it caters to kindergartners, southeastern grocery chain Harris Teeter has graduated. Owner Ruddick (NYSE: RDK) was a strange conglomerate of this 204-store grocery chain and American & Efird, an industrial sewing thread manufacturer. On Nov. 7, Ruddick sold off the smaller sewing operation and narrowed its focus to growing the grocer. Here's why unstitching this subsidiary is good news for stockholders and what to look for in how it spends the cash.

The end of "diworsification"
The combination of a grocery store with $4.1 billion in sales and an industrial thread manufacturer with $301 million in sales is a perfect example of Peter Lynch's "diworsification," or a company acquiring a completely unrelated line of business that makes it worse off. For Ruddick, there was no synergy and no greater sum of the parts for the two drastically different companies operating under one set of managers. By separating the businesses and ending the diworsification, Ruddick saves extra overhead costs, and managers can focus on the core businesses. No corporate manager will think about industrial thread and rotisserie chickens at the same time again, and that's good.

Was American & Efird even a good business? Not until management prepared to sell it off, it seems. American & Efird's sales, which made up 6.8% of Ruddick's total sales last year, stagnated while operating profits fell consistently from 2000 to 2009. From 2006 to 2009, American & Efird's operating profits made up less than 2% of Ruddick's total operating profit. While there was a drastic improvement in 2010, this was probably in anticipation of, or the reason for, the sale of the division. Ultimately, Harris Teeter will not miss its poorly contributing sister business.

Where to stash the cash
With the $180 million in cash from the sale of American & Efird, Ruddick should continue paying down debt, which fell from $356 million in 2009 to the current $283 million. This will save it from interest payments on the outstanding debt, and will further improve its already strong debt-to-equity ratio.

Sources: Fool.com and YCharts.com. Total returns from 11/30/06 to 11/30/11.

By paying down the debt, Ruddick also strengthens its balance sheet. Should stockholders expect an extra bump in its dividend? Not based on Ruddick's history; it increased its dividend from $0.09 per share in 2000 to only $0.13 per share today, and its payout ratio, or the amount of money it gives out as a dividend compared to what it makes, is very close to the industry average.

Ruddick should also use the cash for renovating old stores and for its current initiative of expanding in the metro area of Washington, D.C. The company bought 22% more space for its central distribution center in Greensboro, N.C., during the first quarter of this year to help serve more stores. Now, with extra cash on hand, Ruddick can renovate and fund new stores without increasing its debt. While this may not be a huge traffic driver, it will help it keep pace with the recently renovated Safeway locations, as well as the attractive Whole Foods. I see this is a necessary defensive play.

Of course, there are other things it could do with the money, including paying a special dividend, making a more relevant acquisition, and buying back shares. However, I'm a big fan of companies paying down debt, even if that debt could be used to leverage growth. I'm willing to accept the potential for moderately more controlled growth with a strong balance sheet, over maybe biting off more than it can chew with more leverage.

For an example, look at Whole Foods, which has no debt and is growing gangbusters under its own terms. By contrast, SUPERVALU (NYSE: SVU) is still being held hostage by the debt it took on with the Albertson's acquisition, and must direct massive resources to pay it off. In the meantime, its same-store sales are falling and performance is being hurt. People can debate the best use of this money, but I prefer deleveraging.

Ruddick's recap
Will Ruddick miss its spun-off sewing subsidiary? Not with more streamlined and focused management and extra cash to pay off debt and build new stores. But if management fails to efficiently focus resources, squanders cash for an ill-advised acquisition, or just sits on its larger pile in the bank, stockholders may wish they invested in a different conglomerate -- perhaps an insurance company and failed textile group run by a man called Buffett.

Keep track of how Ruddick spends its new money by adding the stock to your free, personalized watchlist. Or keep track of its competitors by adding Safeway, Kroger, or Whole Foods Market to your watchlist.