Ingles Markets Is Earning More Than What Is Normal (NASDAQ:IMKTA)

Thesis

Ingles Markets, Inc. (NASDAQ:IMKTA) stock has appreciated considerably since the onset of the COVID-19 pandemic. The main reason can be found in the increase in demand. The pandemic led to an increase in demand for groceries as people stockpiled food and household items. This resulted in a boost in sales for grocery stores like Ingles.

In this report, we will take a closer look at the valuation of Ingles Markets, Inc. and examine how it has evolved over time. There have been some noteworthy developments at the company in terms of capital allocation efficiency, and it is worth investigating whether these trends are sustainable. From my analysis, I have some doubts as to whether this is the case. By analyzing key metrics such as return on invested capital (ROIC) and incremental ROIC, there are some indications that the past three years may have been influenced by exceptional circumstances, possibly related to the pandemic.

Ingles has not been expanding its store presence. All capital expenditures have been directed towards remodeling activities and maintenance. This has benefited free cash flow, since the CAPEX ratio to CFO has been half of the pre-pandemic levels. However, this also poses a risk for the company. As underinvestment could lead to a growth deceleration in future.

Additionally, the company’s capital structure has shifted from being heavily debt-focused in 2013, to being more equity-focused today. This change in capital structure could lead to a higher cost of capital and, as a result, higher requirements for return on equity.

SOURCE https://seekingalpha.com/filings/pdf/16222482

Overview

Ingles Markets, Incorporated is a regional grocery store chain operating primarily in the southeastern United States. The company operates over 200 stores in six states, primarily in North Carolina and Georgia. In recent years, Ingles has focused on expanding its private label offerings and renovating existing stores to improve the shopping experience for customers.

In terms of the competitive landscape, Ingles primarily competes with other regional grocery store chains, as well as national chains such as Walmart and Kroger. The company also faces competition from discount retailers such as Dollar General and Aldi, which have been expanding their food offerings in recent years. Additionally, online grocery delivery and pickup services like Amazon Fresh and Instacart are also becoming increasingly popular and could pose a threat to traditional brick-and-mortar grocery stores like Ingles.

Ingles has been able to maintain a strong market position by focusing on providing high-quality products at competitive prices, and by offering a wide variety of private label items. The company’s ongoing efforts to renovate stores and improve the shopping experience should also help it to continue to compete effectively in the crowded grocery market.

Insider Ownership

Insider ownership, according to the company’s most recent proxy statement, Robert P. Ingle, the company’s chairman and CEO, is the largest individual shareholder. Other members of the Ingle family and insiders also hold significant ownership positions in the company. Through the holding of class B shares the insiders have full control of the company with over 70% of voting rights.

Insider ownership can be beneficial for the broader shareholders because it aligns the interests of the management and the owners of the company. When company’s management or directors are also shareholders, they have a personal financial stake in the company’s performance and may be more motivated to make decisions that will benefit the company and its shareholders in the long term. Additionally, insiders may have a better understanding of the company’s operations and industry, and may be better equipped to make informed decisions.

However, it’s important to note that high levels of insider ownership can also lead to potential conflicts of interest and may lead to a lack of transparency in the company’s decision-making processes.

ROIC

Return on Invested Capital, ROIC, is a financial metric that measures a company’s ability to generate profits from the capital invested in its business. It is calculated by dividing the company’s operating income by its invested capital. The ratio is used to evaluate a company’s efficiency at allocating the capital under its control to profitable investments.

ROIC is an important metric because it helps investors and analysts determine how effectively a company is using its capital to generate profits. A high ROIC indicates that a company is using its capital efficiently and effectively, while a low ROIC may indicate that the company is not generating enough returns on its investments.

Warren Buffett, one of the most successful investors of all time, has said, “ROIC is the single most important metric in evaluating a company.” He believes that a company that can generate high ROIC will be more likely to create value for its shareholders over the long term.

As we can see from the graphic above, the company’s Return on Invested Capital (ROIC) has been consistently below 10% over the past decade. However, it’s important to consider some key points when analyzing this metric.

Firstly, the company has made significant progress in reducing its debt, as evidenced by the decrease in the debt-to-equity ratio from 2:1 to 0.5:1 over the past decade. This means that returns generated by the company can be distributed more favorably to shareholders and less money needs to be set aside for interest expenses.

Secondly, while ROIC has been consistently below 10% over the past decade, it’s worth noting that there is no clear trend of improved capital allocation over this period. The past three years may be an anomaly, and this is something to keep in mind when evaluating the company’s performance. This is the main risk for this stock, and it’s the focus of my analysis.

Risks

From a valuation perspective, Ingles Markets, Inc. appears to be relatively inexpensive, when compared to its historical averages. As we can see in the 10-year EV/EBITDA graphic, the company is currently trading at a discount to its 10-year average of 5.7. Additionally, the company has a significant cash reserve of $267 million which can be used to invest in growth opportunities, pay dividends or buy back shares.

It’s worth noting that the market appears to be discounting the company’s recent strong performance, as evidenced by the low multiplier since 2020. Before the pandemic, the multiplier was in the range of 6 to 7, but post-pandemic it has been around 4. This could be indicating that investors are skeptical about the company’s ability to maintain its current level of profitability.

However, if the company manages to continue generating strong financial results as it has in the past 3 years, it’s likely that the multiplier will return to more normal levels, providing a potential upside of more than 30% for the stock. It’s important to keep in mind that the market is forward looking, so it’s pricing in its expectations and projections, and not only past results.

Conclusion

Ingles Markets, Inc. stock has performed exceptionally well in recent years, tripling in value since pre-pandemic levels in 2019 and outpacing the broader market by a significant margin. This can be attributed to the company’s strong financial performance, with profits being used to invest in existing stores and reduce debt. The company’s free cash flow yield has also improved, thanks to a combination of higher cash flow from operations and reduced capital expenditures.

However, it’s worth noting that the company’s free cash flow margin is relatively low at around 4%, which is typical for the industry. It’s also worth considering that the supply chains are normalizing, and with the potential for an economic slowdown or recession, the imbalances between supply and demand may fade away soon.

While Ingles Markets, Inc. has a solid business, it’s not clear what sets it apart from its competitors, and as such, a return on invested capital (ROIC) in the high teens may not be sustainable. If ROIC returns to sub-10% levels, the market may re-evaluate the stock and attribute to it a lower price.