A Fresh IPO with an 8.6% Dividend Yield

Roundy’s Supermarkets (RNDY) is a strong regional food retailer with a local market merchandising strategy that provides high quality food products at competitive prices.  The company was founded in 1872 in Milwaukee and operates 159 retail grocery stores and 97 pharmacies under the Pick ‘n Save, Rainbow, Copps, Metro Market, and Mariano’s Fresh Market retail banners.  The company went public in February 2012 and has a market capitalization of $454 million.  Roundy’s generated $150 million of operating income on $3.8 billion of revenue in 2011.

RNDY began trading on February 8, 2012 at an initial stock price of $8.50.  Currently, RNDY is trading at $10.62, an increase of 25% from its IPO price.  What is unique to RNDY is that it will pay a dividend in 2012.  RNDY plans to pay a quarterly dividend of $0.23 per share.  This represents an annual yield of 8.6% at Roundy’s current price per share.  The dividend payout of ~$40 million represents 60-65% of net income and appears secure, given solid free cash flow generation.  The stock’s dividend yield is much  higher than any other names in the consumer staples universe, and we believe that this provides meaningful downside support to the stock.  In fact, the 8.6% dividend yield is higher than tobacco stocks like Altria Group (MO) at 5.5%, Reynolds American  (RAI) at 5,4%, Lorillard (LO) at 4.8% and Philip Morris (PM) at 3.6%.

Roundy’s is the dominant player in its key markets, with strong market share.  Strong local share is critical in supermarket retailing, given the inherently high fixed cost structure of the conventional model.  Most players in the industry believe that it is critical to be the number one or number two player to compete effectively in a market over the long term.  Roundy’s is the dominant player in its most important markets, holding the number one market share position in four out of its six primary markets. Roundy’s dominance is even more impressive in Milwaukee, its biggest market, where it has 55% share. The company’s average share in all markets is 35%, amongst the highest in U.S. food retail.

While the company’s core business provides no real opportunity for growth, we believe their expansion into the adjacent Chicago market presents an underappreciated opportunity.  Chicago is the third largest market in the United States, with struggling market leaders in Supervalu and Safeway.  Roundy’s is rolling out a differentiated format focused on high-quality fresh product at highly competitive prices.  Roundy’s management team has a history of success in the market, and the company has negotiated a labor advantage with the local union.  The company has only five stores in the market currently but plans to open four to five annually.  We do not expect Chicago to provide a material lift to earnings in the near term; however, it could be a catalyst within the next few years if successful.

RNDY estimates fiscal 2012 EPS of $1.42, fiscal 2013 EPS of $1.50, and fiscal 2014 EPS of $1.65.  At a PE of 10, RNDY should trade at $14.20, a 33% increase from its current value.  At a stock price of $10.62 with a 8.6% dividend yield, we believe the market has not properly valued its steady income stream and assigned value to the growth in Chicago.  Investors should at least clip a steady coupon on the dividend and could see solid appreciation once the company’s story becomes better understood.