Ruddick is an obscure conglomerate headquartered in Charlotte. In addition to running Harris Teeter, the company also operates American & Efird (A&E), which manufactures industrial and consumer sewing thread.
A person could rightfully ask why a company would be in these two very different businesses. I don't know the answer to that question, but would hazard a guess that they're kept together so the cash from A&E can be invested into Harris Teeter's growth opportunities. The thread business may not be sexy and high-growth, but it is quite profitable: A&E's operating profit margins are 13.8% compared to 2.4% at Harris Teeter. To put that another way, even though A&E only accounts for 13% of Ruddick's overall sales, it generates 47% of its operating profit! Making the business even more attractive, the thread business requires substantially lower capital expenditures than its grocery counterpart.
Business Trends, Stock Price Performance
Business during the past three years has been moderate, at best. Sales grew at a compound annual pace of 7%, while earnings moved up at a 5% pace. Even though Harris Teeter's sales rose a little faster than A&E's, the threadmaker enjoyed more rapid operating profit growth at 12% compared to the grocery stores' 5% pace. Those aren't the kind of numbers associated with growth companies, but at least they are both in an upward trend.
The stock performance has been worse than its operating stats. Although it rose from the $12-$14 per share range in late 1996 to the low $20s in early 1999, it lost all of that gain to fall back into the $12-$13 range. At this price, the stock goes for about 11x earnings over the past 12 months. Given this low valuation, the stock could be attractive if the business model is attractive and the company has long-term growth opportunities.
Cash Flow
We've already taken a quick look at Ruddick's income statement. To really get to know a company, however, you've also got to do a little digging through the balance sheet and cash flow statement. Here you can learn a lot about what's going on at a company. The first thing I like to get a picture of is free cash flow generated by the business. While this number can be volatile, it gives an indication about what's going on.
($ millions) 1999 1998 1997 Operating cash flow: $ 86 $123 $ 95 Capital Expenditures: $ 97 $ 95 $115 Free Cash Flow: - $9 $ 28 $-20
Combining free cash flow over the past three years, Ruddick has been basically cash flow neutral. This means the company hasn't needed much outside financing to achieve its growth. (This isn't exactly true... since the company pays a $15 million annual dividend to shareholders, debt has increased over the past few years.) While the company doesn't need substantial external capital to grow, reinvesting almost all those profits has only resulted in 5% annual earnings per share growth.
Most of the company's capital expenditures (CAPX) were invested in the Harris Teeter Division. In each of the past three years, CAPX exceeded $75 million for Harris Teeter, whereas A&E CAPX ranged from $15 - $30 million. That's somewhat interesting, particularly since A&E enjoyed more robust earnings growth during that period.
Balance Sheet and ROIC
The balance sheet looks to be in pretty good shape. The company's debt-to-equity ratio is a manageable 45%, and its inventory and accounts payable growth seem to be pretty much in line with (actually a little lower than) sales growth. The other total assets account jumped up $16 million last year, accounting for a good portion of the reduction in operating cash flow.
We should also take a look at return on invested capital (ROIC), after-tax operating profit divided by (total assets - non-interest-bearing current liabilities):
1999 1998 1997 1996 ROIC 8.2% 7.7% 8.7% 8.9%
Although it edged up in 1999, the three-year ROIC trend has been negative, indicating that the return on incremental dollars invested in the business has been decreasing. On an absolute basis, the ROIC is below the 10%-11% weighted average cost of capital (WACC), assuming a required 15% cost on equity. The company would meet its WACC if an investor only required a 12% equity return -- which may describe some investors, but not me.
When calculating after-tax operating profit, I noticed that Ruddick's tax rate has gone up from 30% to 38% in the time frame being evaluated. According to the 10-K, this increase was caused by a change in the tax treatment of company-owned life insurance that was phased in from 1997-1999. Since the company's tax rate has been increasing, its operating performance has been better than net income indicated. I went back to calculate operating profit growth (rather than net income growth) and found a 9% increase over the past three years.
In sum, the financial picture at Ruddick is mediocre. The company is basically self-funding, but three-year earnings growth has been a tepid 5% (9% if you look at after-tax operating profit). Return on invested capital is a ho-hum 8.2%.
Qualitative Scan
The grocery store business is very competitive. Wal-Mart (NYSE: WMT) has been invading the business with its Wal-Mart supercenters and is testing Neighborhood Market, which is a regular grocery store. This competitor brings its efficiency and economies of scale, keeping pricing low throughout the business. Responding to this threat, the industry has seen tremendous consolidation. Kroger (NYSE: KR) acquired Fred Meyer, Albertson's (NYSE: ABS) picked up American Stores, and Delhaize America (NYSE: DZA) -- which operates Food Lion -- is in the process of acquiring Hannaford Brothers (NYSE: HRD).
This increasing competition, combined with low inflation, has made the grocery business much tougher to win. While Harris Teeter's very slow operating income growth is disappointing, it looks Herculean compared to the dismal performance of chains like Winn-Dixie (NYSE: WIN). Being well entrenched in its local markets and catering to an upscale demographic group should help Harris Teeter continue to move ahead. Nonetheless, maintaining its moderate performance will require continued management focus.
I have to admit not knowing a lot about the industrial thread business. My hunch is that it is a fairly competitive, modestly cyclical business. Although those characteristics are not too attractive, A&E seems to have a pretty good position and achieves nice returns. More importantly, it is a cash cow that requires only limited capital investment. I would expect to see flat to modestly rising profits over the long-term, with its free cash being plowed into Harris Teeter.
Conclusion
Right now, I would classify Ruddick as a decent business trading at a fair price. In other words, I don't find a particularly strong reason to put it in my portfolio, which will hopefully consist of great businesses at cheap/fair prices or decent businesses at cheap prices.
Before buying into the company, I would want to see evidence that its fairly steep investments in Harris Teeter provide satisfactory returns. Right now, I don't see enough evidence of that happening. However, Harris Teeter's preeminent position in the upscale grocery segment could make it an acquisition candidate for a chain wanting to gain a foothold in the demographically attractive North Carolina market. That being said, I rarely buy companies as takeover candidates unless other attributes make them a promising investment.
Fool on!
