After Digging a Hole For Itself, Can Roundy's Turn It Around?

Mr. Market hasn't liked the business developments out of regional grocer Roundy's lately, pushing the company's share price down sharply in 2014. Is it time to buy in?

Jul 16, 2014 at 2:00PM

Rndy

Source: Roundy's

Shareholders in regional grocer Roundy's (NYSE:RNDY) are still waiting for a payoff. Basically, Roundy's has been hurt by negative comparable store sales growth, mostly due to rising competition in its markets from major grocery players, like Whole Foods Market (NASDAQ:WFM) and Wal-Mart Stores (NYSE:WMT). The company's stock price dropped sharply in the first half of the year, continuing a generally poor price performance that dates back to its initial public offering in 2012. Given all these negatives, and the obvious hole that Roundy's has dug for itself, is it possible that the company is now worth closer inspection by Foolish investors?  

What's the value?
Roundy's is a niche player in the grocery business, operating a geographically concentrated network of roughly 160 stores under a handful of brands, with a major presence in the Milwaukee and Chicago metro areas.  Unfortunately, the company's relatively small size and multiple brands haven't allowed it to achieve meaningful economies of scale in its business, culminating in a lack of underlying profit growth.  Consequently, management has chosen to downsize its traditional grocery banners and focus on its premium Mariano's banner, which is expected to eventually account for a majority of Roundy's overall store base.

In its latest fiscal year, though, Roundy's updated strategy failed to produce the desired outcome, highlighted by another decline in comparable store sales.  While the company managed to maintain its gross margin, thanks to a focus on higher-margin, non-perishable product categories, it was hurt by a greater amount of corporate administrative costs implicit in its expanding store base, as well as higher occupancy costs from its push into metro Chicago.  The net result was a double-digit decline in adjusted operating income, down 13.3%. This is disheartening as the drop impairs Roundy's ability to both grow its store network and improve its balance sheet.

Looking into the crystal ball
Of course, investors are mostly interested in ascertaining whether Roundy's can find its way to a positive profit growth trajectory in the future.  Unfortunately, based on the company's latest fiscal quarter, accomplishing that feat would seem to be a long shot anytime soon, evidenced by a double-digit decline in adjusted operating income during the period.

A large part of the company's problem is that the major grocery players want an ever larger share of the premium segment, an area that has been growing at a faster rate than the rest of the grocery business, partially due to rising consumer demand for natural/organic product offerings.  Case in point is Whole Foods Market, the king of the natural/organic segment, which is expecting to add nearly 10% more stores to its overall network in the current fiscal year, including a greater presence in the Chicago metro area: Roundy's backyard.  While the company's operating profit growth has been less than expected in FY2014, leading to near-term weakness for its stock price, it continues to generate strong operating cash flow, funding a further expansion of its franchise across the country.

If that weren't enough...
Wal-Mart Stores, the nation's leading grocer with a footprint of more than 4,000 stores, is also looking to capture more sales in the premium segment, recently partnering with the Wild Oats brand to bring a significantly greater selection of natural/organic product offerings into its stores.  In addition, the company is upping its investment in its small-format Neighborhood Markets unit, hoping to expand the unit's footprint to 200 stores by the end of the current fiscal year.  All told, it adds up to a strategy of trying to win the hearts and minds of the premium product-oriented customer, which will only increase the competitive pressure on smaller, less-efficient competitors, like Roundy's.

The bottom line
Roundy's is undoubtedly cheaper than it was at the start of 2014, after losing almost half of its market value.  Despite this, the company's most recent financial results spark little confidence that profit growth is just around the corner, a necessary ingredient for a sustainable move higher for its stock price.  As such, investors should probably wait for another financial update prior to betting on this small cap.

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John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Robert Hanley owns shares of Whole Foods Market. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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