Is Niche Supermarket Chain Roundy's a Buy After Picking up Safeway's Castoffs?

Wisconsin-based supermarket chain Roundy's (NYSE: RNDY  ) made a bold statement about its future growth prospects in December, agreeing to buy 11 of Safeway's (NYSE: SWY  ) metro Chicago-area stores. The purchase nearly doubles Roundy's position in the Chicago market, where it operates under the Mariano's brand name. Safeway is exiting the market after failing to compete against a host of well-heeled competitors, from Whole Foods Market at the top end to Wal-Mart at the bottom. So, should investors bet on a growth trajectory for Roundy's?

What's the value?
Despite a food wholesaling history that dates back to 1872, Roundy's is a relative newcomer to the food-retailing space, moving aggressively into the area only after the company's 2002 acquisition by investment firm Willis Stein. Roundy's operates stores that target a primarily value-conscious customer base using a variety of banners, including Pick N' Save, Rainbow, and Mariano's. With a top market share in most of Wisconsin's major cities, including Milwaukee and Madison, the company has had to search elsewhere for growth, hence its move south into the larger metro Chicago market.

In FY 2013, Roundy's has posted mixed results, with a small top-line gain being more than offset by a drop in its profitability level.  The company's operating margin was hurt by its primary focus on a value-priced customer base, a segment that requires heavy promotional activity in order to drive customer traffic. Roundy's was also negatively affected by the health-care industry's continued shift toward generic prescriptions, a trend which hurt the company's pharmacy business, a major source of higher margin sales that accounts for roughly 16% of total revenue.

While Roundy's may see gold in selling food stuffs to Chicago's roughly 2.7 million residents, investors should be cognizant of the failures of like-minded competitors to crack this high-cost market. Safeway's Chicago area stores, operating under the Dominick's brand name, have been a drag on its overall profitability lately, reporting a -3.4% segment margin in the current period. If a larger competitor like Safeway, owner of a strong ecosystem of bakeries, bottling plants, and procurement facilities, is heading for the exits, perhaps Roundy's desire to fill the void isn't the wisest of decisions.

Chasing the leader
Of course, Roundy's is trying to reduce its reliance on its home Wisconsin market through its ambitious growth plans, while also hoping to create greater efficiencies in its overall network. The company's strategy of pursuing a general food-retailing business, as opposed to concentrating on a specialty niche, will likely require it to gain much larger scale than its current base of roughly 160 stores, if it hopes to compete with mega chains like Kroger (NYSE: KR  ) .  Despite being the neighborhood grocery category's kingpin, Kroger continues to be in growth mode, recently agreeing to buy smaller competitor Harris Teeter for $2.5 billion, a transaction that added 10% more stores to its overall network.

In FY 2013, Kroger has posted generally favorable financial results, with a 3.7% top-line gain that included its 40th straight quarter of comparable-stores sales increases. The company is a master at operating in a low-margin environment, having cobbled together a strong supporting network of production facilities, which allows it to produce 40% of its growing roster of private- label product offerings in-house.

In addition, Kroger has built a massive fuel operation, accounting for roughly 20% of total sales, which it uses to create customer brand loyalty and bring higher traffic into its stores. The net result of the company's efforts has been strong operating cash flow in the current period, allowing Kroger to further improve its competitive position and continue to reward shareholders with stock buybacks and dividend increases.

The bottom line
The growth plan at Roundy's has the company expanding to the big city, specifically the Second City, as the next step in a progression toward becoming a national player. However, ultimate success in that endeavor is far from guaranteed, given the recent exit of competitors, like Safeway and Supervalu, which were each unable to build a sustainable business in that geography. While Roundy's is an interesting small-cap story in the grocery business, more so given its current 5% dividend yield, investors should force it to deliver on its growth plans prior to taking a position.

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  • Report this Comment On January 21, 2014, at 6:34 PM, SaraAndews wrote:

    The approach to this analysis is sound in principle, but it overlooks much important history. The management team now at Roundy's ran Chicago's Dominick's in the 1990s when it became a wildly successful chain in Chicago. Safeway bought Dominick's for over $1Billion in 1998. Safeway kicked out Dominick's successful management and it almost instantly failed--it was not "lately" as the author writes. Four years later, Dominicks was rumored to be on the block for less than a 1/3 of what Safway paid for it.

    The new stores run in Chicago under the Mariano's banner are much higher end than other Roundy's stores. They do twice the business of most Chicago grocers. Mariano's lots have lines waiting to get in and they are more sought after by communities than even Whole Foods or Trader Joes.

    The reason Safeway pulled out of the Chicago market is that Roundy's strategically placed their new Mariano's adjacent to Safeway's best Dominick's locations. Roundy's basically put Safeway out of business in Chicago and are giving Jewel a run for their money. And Roundy's picked up only the best Dominick's/Safeway locations -- they should know since they built those stores when they were with Dominick's 20 years earlier.

    Roundy's may be ho-hum in Minnesota and Wisconsin but in Chicago it's higher end format Mariano's is a category killer. I have no stock in RNDY nor do I know anyone who works there. I'm just huge fan. How many grocery stores have fans like Apple does? Not many. The Mariano's stores are different than other Roundy's stores and it's a huge success. I appreciate the author's efforts, but please read the Chicago stories on Mariano's---they have headlines like, "I was upset about Dominick's but I'm even more thrilled to be getting Mariano's in it's place" (CBS Chicago News) and "How come my Dominick's isn't Mariano's Worthy?" (Chicago Tribune).

  • Report this Comment On January 22, 2014, at 2:37 PM, djlresearch wrote:

    Sounds like an outdated rehashing of an 8k. Dividend? Really.

    SaraAndrews makes some good points. How come my Dominicks isn't Mariano's worth? Because they don't have enough money to buy them all. So they have to pick the best ones.

    Roundy's put Dominicks of business for the same reasons Walmart, Meijer, Woodmans, Festival,and HyVee are putting Roundy's out of business in Wisconsin - opening stores near both best and marginal stores.

    In the end its usually the company that makes the most money, not the nicest stores, that is left standing.

  • Report this Comment On January 22, 2014, at 4:28 PM, SaraAndews wrote:

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