Not Just Whistling Dixie

01/07/2010 9:36 am EST


George Putnam

Editor, The Turnaround Letter

George Putnam, editor of The Turnaround Letter, says a Southeastern supermarket chain has a good franchise, a solid balance sheet, and a deeply undervalued share price.

Founded in 1925, Winn-Dixie Stores (Nasdaq: WINN) is one of the largest food retailers in the southeastern United States, with 515 supermarkets across Florida, Georgia, Alabama, Mississippi, and Louisiana.

After years of ignoring competitive pressures and underinvesting in its stores, a series of merchandising miscues forced the company into bankruptcy in February 2005. Winn-Dixie emerged from Chapter 11 in November 2006 with a new management team in place and a virtually debt-free balance sheet.

After taking the helm in December 2004 and guiding Winn-Dixie through Chapter 11, chief executive officer Peter Lynch is actively modernizing the company’s stores and taking other steps to respond to the competition. Lynch plans to have half of the company’s stores remodeled by the end of fiscal 2010 (ending in June).

The program is having a positive effect, with the revamped stores showing a 7% sales increase [despite] difficult economic conditions. Moreover, Winn-Dixie is taking advantage of its local knowledge to implement a neighborhood merchandising and marketing initiative. By tailoring each store’s inventory and marketing to its local neighborhood, the company is able to compete more effectively against national powerhouses such as Wal-Mart Stores (NYSE: WMT).

Notwithstanding the challenging economy, Winn-Dixie has been able to post fairly steady financial gains since emerging from Chapter 11 in late 2006. Nonetheless, investors—perhaps because of the company’s stint in Chapter 11—have consistently given the stock a much lower valuation than those of comparable food retailers.

For example, Winn-Dixie currently trades at [an enterprise value of] only 0.06x revenues compared to an average of 0.27x for its four most comparable competitors. Similarly, Winn-Dixie trades at less than three times cash flow (measured by EBITDA—earnings before interest, taxes, depreciation and amortization) compared with [from] 4.8x to nearly seven [times] for the comparable companies, several of which carry much heavier debt burdens.

In addition to its debt-free balance sheet, Winn-Dixie has another financial advantage: The company has more than $500 million in loss carry-forwards it can use until 2025 to reduce its taxable income, thereby further increasing cash flow.

The whole supermarket sector appears to be out of favor with investors right now, with many of the stocks in the group, including Winn-Dixie, trading relatively close to their lows set last March.

We think investors will begin to come back to the sector in the not-too-distant future. When they do, they are likely to recognize the progress that Winn-Dixie has made since emerging out of Chapter 11 and give the stock a significantly higher relative valuation.

We recommend buying Winn-Dixie up to $15. (It closed above $10 Wednesday—Editor.)

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