Winn-Dixie WIN
February 22, 2002 - 11:11pm EST by
2002 2003
Price: 14.15 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 2,000 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Winn-Dixie is an established southeastern grocery chain with over 1,150 supermarkets based in fourteen contiguous states and the Bahamas. Operating under the Winn-Dixie, Save Rite, Thriftway, City Markets, Goodings and Jitney Jungle names, the company also runs 16 distribution centers and a like number of manufacturing plants.

Trading at $14.15, there are 140.8 million fully diluted shares outstanding for an equity market capitalization of nearly $ 2.0 billion. Net debt (including capital leases) totaled $590 mm at 1/9/02. On expected diluted EPS for the current fiscal year (ending 6/02) of $1.05, the stock trades at 13.5X.

The fruits of a long term restructuring effort are finally beginning to spring forth. One coup in this ongoing initiative was the hiring of industry veteran Allen Rowland as President/CEO in November 1999. Rowland joined WIN after a short stint as President of Smith’s Food and Drugs, a company sold during his tenure to Fred Meyer (which was later sold to Kroger) . Previous to this position he spent 25 years at Albertson and eventually had retail operating responsibility for a large portion of the United States.

Within months of joining the company Rowland declared the “Plan of Restructuring”, recognized the first of a series of charges, and set about remaking the management and operational infrastructure. In the years just prior to Rowland’s arrival the company had invested heavily in developing new and larger “Marketplace” stores, and retrofitting and closing aging properties. This early spade work enabled the new CEO to complete two small acquisitions, fund the launch of a new marketing campaign, hire new senior management, and declare the restructuring complete in just under 16 months.

Earnings for the most recent quarter exceeded expectations and WIN raised guidance for the fiscal year.

Winn-Dixie possesses a solid franchise and has plenty of opportunity for cost reduction and efficiency improvement. Furthermore, the business has historically produced strong returns on equity with very little leverage, and generated decent free cash flow.

Assuming the new management team succeeds in bringing pre-tax margins up to industry average levels over the next 12-24 months, this is a $20 stock. That’s 40% appreciation potential exclusive of any expectation for revenue growth. Should the recently launched “Real Deal” branding campaign have its desired impact on same store sales, the value in the business will grow further.

If the new team fails it’s hard to see how WIN, despite management’s current protestations to the contrary, can remain an independent company. Considering the strong Florida franchise and presence throughout the south, the company is a very attractive acquisition candidate.

The retail grocery industry is a huge and fragmented. The top competitors by market share are as follows:

Total US Grocery Sales = $682.3 billion
Estimated Industry Growth = 2-3%

Share Stores
1. Wal-Mart 9.8% 1,060
2. Kroger 7.4% 2,392
3. Albertson’s 5.6% 2,541
4. Safeway 5.0% 1,759
5. Costco 4.3% 369
6. Sam’s Club 4.3% 500
7. Ahold USA 3.4% 1,600
11.Publix 2.2% 684
12.Winn-Dixie 1.9% 1,153
13. A&P 1.6% 797
Others 51.2%
(Source : Supermarket News)

At the store level, higher local income levels and population densities correlate with above average sales per square foot and labor hour, and annual revenue growth. Picking the right location for a new store and adjusting your store base to shifting demographics are critical to long term success.

Adoption of supply chain practices, low employee turnover, and common ownership of both stores and distribution centers correlate well with leadership in cost and service (product availability)across store formats. (Source : The Food Industry Center).

Superstore and club formats clearly represent major competitive threats to the neighborhood and chain grocer. With scale purchasing economies, “warehouse as store” layout, and do-it-yourself service, these competitors are able to offer rock bottom prices on a broadening array of frequently purchased items. Wal-Mart is currently the nation’s largest grocer.

Despite the significant inroads made by superstores, the largest chains have managed to thrive by adopting the operational/back end strategies of their superstore rivals, offering competitive prices on the most contested items, and innovating their in-store service offerings (deli, drug store, banking etc)..

So, in this large fragmented industry well capitalized competitors have staked out unique competitive positions. Wal-Mart and Kroger’s both co-exist and grow. Less well capitalized and significantly smaller competitors will either be acquired or fail.

During the mid to late 90’s Winn-Dixie faced intense competition from the superstores, clubs and Publix (a local employee-owned rival). With WIN’s base of relatively smaller stores, the company lost share to expanding large format rivals. WIN responded eventually by spending initiative approximately $1.8 billion on new stores, remodeling and acquisitions during the 1997-2001 period. This investment was disruptive but necessary,

WIN maintained a regional operating structure long past its usefulness. While competitors centralized purchasing and shared scale-based product cost savings with customers, WIN maintained 10 autonomous regional purchasing departments and benefited little from its scale.

The table below highlights sustained CAPEX activity :

1997 1998 1999 2000 2001 Total
CAPEX ($mm) 423.1 369.6 345.7 213.9 437.1 1,789
Dep/Amort (291.2) (330.4) (292.4) (256.7) (183.6) (1,354.3)

New/Acquired n/a 84 79 34 94
Avg. Sq. Ft. (000) n/a 50.0 51.0 52.3 38.5

Closed n/a 90 59 143 20
Avg. Sq. Ft.(000) n/a 30.5 33.6 41.4 34.8

Expanded/Renovated n/a 136 64 42 6

The Davis family founded WIN in 1925 and continues to hold over 40% of the stock. Up until September 2001 the family, led by Board Chairman Dano Davis, elected to pay shareholders dividends of $0.085 per month in advance ($1.02 per year). Dano also chose to finance the business in an extremely conservative fashion. During the 1997-2001 period the business carried relatively little net debt. As a result of these decisions, WIN was unable to respond to the competitive challenges earlier and more aggressively.

The new dividend policy ($0.05 per quarter in arrears), announced during the hysteria following the WTC incident, contributed to the 40% drubbing taken by the stock which fell as low as $10 per share.

Though a restructuring of sorts was clearly underway before Rowland’s arrival, the new CEO unveiled his plan and charge in April 2000. Key elements of the plan included :

- Executive and divisional management reduction/realignment
- Consolidation and elimination of multiple divisions
- Centralized procurement, marketing and merchandising
- Headcount reduction of 11,000
- Closing unprofitable stores, store departments and manufacturing/distribution centers
- Retrofitting of 650 stores
- Improved inventory management capabilities

Charges of approximately $600 mm were eventually taken in expectation of reducing annual costs by $400 mm annually. On a revenue base of $13.5 billion, that savings can add 3% to the pre-tax operating margin.

(Please see company documents for further detail)

I value this business on discounted cash flows assuming no revenue growth during the next five years and a step wise recognition of the cost savings described above. Specific assumptions include:

Sales Base (’02) $13,500
Sales Growth
Year 1-5 0%
Thereafter 2%
EBIT Margins
Year 1 2%
Year 2-5 0.5% per year increase
Thereafter 4.5%
Incr Capital/Sales 20%
Tax Provision 38.5%
Cash 138.7
Debt +Cap Lease 721.2
Discount Rate 10%

These assumptions get me to a value in the $20-$21. Add 2% per year in revenue growth (years 1-5) and you come up with $22-$23 per share.

It is also interesting to note that this business is the cheapest in its universe, perhaps due to heavy insider ownership, previous credibility issues, the change in dividend policy and the fear that competitors will continue to steal customers and erode profitability. On the latter point, despite the presence of strong competitors the company is finally getting its house in order operationally.

I am confident in management’s ability to match the competition on margins in the near term. Cutting costs s a lot less risky (particularly considering the $1.8 billion invested in the infrastructure over the past few years) than stimulating revenue growth. For this reason, I like the risk/reward associated with this investment.


Recognition of the cost saving benefits associated with a substantial restructuring of the store base, operations, and organizational structure, and upgrading of the senior management team.
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