Don’t Let this Double-Digit Dividend Fool Ya

Roundy's (NYSE: RNDY  ) , a supermarket chain based in Milwaukee, offers a dividend yield of more than 16%. But, in the same way that a grocer puts the best strawberries on top, that attractive dividend yield covers some very ugly product underneath. Crushed by debt and starving for profits, Roundy's won't achieve any long-term goals for Foolish investors.

A look at the reasons
Roundy's operates in a very competitive sector, with tight margins and low profits against giants such as Wal-Mart (NYSE: WMT  ) , Target (NYSE: TGT  ) and The Kroger Co. (NYSE: KR  ) . The company is handicapped with a heavy debt load, due to expansion in the Chicago area and $590 million paid to its private equity owners. Roundy's went public earlier this year to generate funds to pay down its debt, not to reward its new shareholders. The stock has fallen about one-third in value since the initial public offering.

A major threat to the operations of the company emanates from the disturbingly low interest coverage ratio, the number of times a company can make its interest payments with earnings before taxes and interest. With so much debt, Roundy's will have a very difficult time improving its stores, or pricing to increase profits and attract more customers.

The high dividend payout ratio also imperils the ability of Roundy's to fund future business growth. The dividend payout ratio is the amount of earnings utilized for paying the dividend. The grocery store industry average is 30%; Roundy's tops 80%. That makes it very difficult for Roundy's to compete, when so much of its earnings are dedicated to paying the dividend and servicing the debt, rather than expanding operations.

Metric

Roundy's

Wal-Mart

Target

The Kroger Co.

Industry Average

Net Profit Margin

0.01%

0.04%

0.04%

0.01%

0.02%

Dividend Payout Ratio

82%*

32%

28%

40%

30%

Debt-to-Equity Ratio

2.32

0.78

1.16

2.14

1.11

Interest Coverage Ratio

2.10

12

7.50

3

3.70

Source: Motley Fool CAPS and *The Dynamic Dividend

Value trap, not value play
Valuations become alluring when a stock falls in price. Roundy's has steadily fallen by more than 35% in 2012. That lures unwitting investors, tempted by a shrinking price-to-earnings and price-to-book ratio, with a soaring dividend yield that seemingly looks more attractive. But, like Supervalu (NYSE: SVU  ) , another supermarket chain in trouble with a declining share price, Roundy's is a classic value trap. While earnings per share rise for the overall supermarket sector, they are falling for both Roundy's and Supervalu. Judging from the high short float for the two companies, the investment community expects the share prices to plummet even more, despite the high dividend yields.

Metric

Roundy's

Supervalu

Industry Average

Price-to-Sales-Ratio

0.07

0.02

0.28

Price-to-Book-Ratio

0.84

0.00

2.40

Quarterly EPS Growth Rate

(19.98%)

(285.87%)

17.80%

Price Decline for 2012

37%

61.75%

n/a

Short Interest

12.18%

41.75%

n/a

Source: Motley Fool CAPS and FIVIZ

Too much like Supervalu, for comfort
Like Supervalu, Roundy's high dividend likely aims to keep investors from heading for the checkout line. But, with its staggering debt load, troubling interest coverage ratio, and falling EPS, Roundy's should not be paying a dividend. Indeed, management has warned that the high debt might curtail future dividends.

Foolish investors should ignore the temptations of its high dividends and low valuations. Before anyone can consider it a worthwhile long-term holding, Roundy's needs to increase its earnings and lower its debt.

While Roundy's finances are not suitable for long-term investing, these three stocks can help you achieve your goal of retiring rich. The best investing approach is to choose great companies and stick with them for the long term. Roundy's is not there yet. But in our free report "3 Stocks That Will Help You Retire Rich," we name stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.


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