Ingles Markets: Expansion Plan, Quite Undervalued (NASDAQ:IMKTA)

Ingles Markets, Incorporated (NASDAQ:IMKTA) announced an expansion plan to add new stores, and is making significant capital expenditures, which will most likely bring significant economies of scale and FCF growth. If we review the company’s previous balance sheet in the last 10 years, IMKTA delivered impressive equity growth and book value per share growth. In my view, IMKTA knows well how to open new stores, search for locations, and deliver what customers need. I would be expecting the same to happen in the coming years. There are some risks coming from the current equity structure, however the stock, in my view, appears very undervalued at its current price mark.

IMKTA: Equity Growth, And Lower Net Debt

Ingles is a supermarket chain in the Southeast, operating 198 supermarkets in North Carolina, Georgia, South Carolina, Tennessee, Virginia, and Alabama.

I did check the most recent financial statement reported in the last 10-Q, which included non-GAAP EPS of $1.67, and revenue of $1.39 billion. However, I think that reviewing the company’s last 10 year financial statements makes more sense. In the last 10 years, the company reported total assets growth as well as book value and book value per share growth.

It is also worth revising the decline in the total net debt and the overall increase in total equity. Given these figures, I would say that IMKTA really knows what it does. In my view, further use of the expertise in new markets may bring further business expansion.

Net Income Growth, And Unlevered FCF Growth

In the last decade, both the net income and the free cash flow increased significantly.

The company also maintained the total amount of level dividends distributed to shareholders, and increased the capital expenditures. In my view, management did find new markets to invest the cash flow from operations. With this in mind, in my opinion, we could expect further growth in the coming years.

Long-term Debt, And Interest Rate Paid

According to the company’s most recent 10-k, the long-term debt includes 4% senior notes maturing 2031 and other debt agreements linked to the SOFR. I do not think investors may be afraid of the total amount of debt or the interest rate being paid. Given the company’s debt outstanding, I used a conservative cost of capital of 6%. However, other investors could be using a lower cost of capital because IMKTA appears to be conducting negotiations with debt investors.

My Free Cash Flow Expectations, My Price Target, And Competitors

My financial model includes beneficial expectations about future capital expenditures and construction of new stores. Given the total amount of debt and the current balance sheet, IMKTA appears in a good position to open new stores, acquire new sites, and make new upgrades. In my view, these investments will most likely bring net sales growth and FCF growth.

Capital expenditures totaled $143.0 million for the nine-month period ended June 29, 2024. The Company’s capital expenditures include the construction of one new store, the expansion and remodeling of existing stores, the acquisition of sites, new technology, and upgrades of the Company’s transportation fleet and facilities. Source: 10-Q

Besides, in my view, it is worth noting that IMKTA appears to be executing a plan to renovate and add target markets. As a result, I think that we could see an improvement in future net sales growth. I would also expect that economies of scale could enhance net income growth and FCF growth.

The Company has an ongoing renovation and expansion plan to add stores in its target markets and modernize the appearance and layout of its existing stores. Source: 10-k

I also think that the company’s ability to pay dividends since 1993 will most likely be appreciated by new investors and existing shareholders. Demand from dividend investors and other value investors could accelerate the stock price.

Since December 27, 1993, the Company has paid regular quarterly cash dividends of $0.165 per share on its Class A Common Stock and $0.15 per share on its Class B Common Stock for an annual rate of $0.66 and $0.60 per share, respectively. Source: 10-Q

I cannot say whether inflation was beneficial or detrimental for IMKTA’s net income growth. However, in my view, recent declines in inflation will most likely lower the level of perceived risks from certain conservative investors. As a result, the company could see institutions buying shares again.

During the past twelve months, inflation has declined from recent highs, impacting food costs, transportation costs, and labor costs. Source: 10-Q

My free cash flow expectations follow pretty much the trend seen in the last ten years. With cost of capital of 6% and terminal EV/FCF of 9x, I obtained a total enterprise value of $2 billion and a target price of close to $112 per share.

• NPV of FCF: $1,008.39 million
• NPV of TV: $1,287.94 million
• Total EV: $2,296.33 million
• Target Price: $112.74

According to Seeking Alpha’s valuation tool, the sector median P/E TTM GAAP is close to 21x, which is significantly higher than IMKTA’s P/E TTM GAAP. The company’s Ev/TTM EBITDA is close to 4x-5x, and peers trade at close to 12x.

Competitors include other companies operating in the consumer staples sector such as Grocery Outlet Holding Corp. (GO), Albertsons Companies, Inc. (ACI), or Sprouts Farmers Market, Inc. (SFM).

Risks From Changes In The Labor Markets

Considering previous quarterly reports and annual reports, IMKTA could suffer significantly from labor market tension, changes in the regulations, or increases in salaries. As a result, the company may see a decrease in both operating margins and future free cash flow growth. In the last quarterly report, the company noted certain increases in the cost to attract associates. What we saw in the last quarter may continue in the near future, and may damage future financial figures. Other costs that could also deteriorate future profitability are insurance costs as well as repair and maintenance costs.

Salaries and wages increased due to increased labor market competition, which has increased the Company’s cost to attract and retain associates in the Company’s market area. Source: 10-Q

Risks From The Equity Structure

The company appears to be controlled by a large shareholder, which owns a significant amount of voting power. Under certain circumstances like acquisition attempts, changes in the Board of Directors and other relevant decisions of the majority shareholders may not be in line with the interest of minority shareholders. With this information in mind, certain investors may not be willing to acquire stock of IMKTA.

Mr. Ingle II’s beneficial ownership represented approximately 72.2% of the combined voting power of all classes of the Company’s capital stock as of September 30, 2023. As a result, Mr. Ingle II has the power to elect a majority of the Company’s directors and approve any action requiring the approval of the holders of the Company’s Class A Common Stock and Class B Common Stock, including adopting certain amendments to the Company’s charter and approving mergers or sales of substantially all of the Company’s assets. Source: 10-k

Risks From Increases In The Interest Rates And Lack Of Research From Analysts

IMKTA uses some debt to finance capital expenditures. The total amount of debt is not significant, however future increases in the interest rate could lower net income growth and free cash flow growth. Besides, analysts out there could increase the cost of capital used in their valuation models. As a result, the company’s implied valuation would most likely fall, and the stock price could fall too.

I could not find many analysts covering the stock, and the amount of communication delivered by the company is not that significant. In my view, if there is little research and communication efforts about IMKTA in the market, the valuation could decline even lower. From here, I cannot really say whether analysts are going to write about the stock.

Risks From Leasing Agreements

IMKTA owns some properties, and leases locations to run its super markets. In the future, IMKTA may have issues in finding adequate locations, or new lease agreements may not be as profitable as in the past. In the worst case scenario, if the company cannot sign adequate leasing agreements, I think that expansion into new territories could not happen that fast. Net sales growth, net income growth, or free cash flow growth could lower. As a result, I think that we could see stock price declines.

There Are Two Type Of Shares

There are class A shares and class B shares. Class B shareholders have the right to 10 votes per share, while class A shareholders have the right to only one vote per share. There are many companies in the market trading with similar class types. With that being said, in my opinion, investors have the right to know that this is not beneficial. Class B shareholders pretty much control the future of the company. It may be difficult for class A shareholders to make changes inside the Board of directors. Certain investors may not buy class A shares because of the existence of class B shares.

The voting powers, preferences and relative rights of Class A Common Stock and Class B Common Stock are identical in all respects, except that the holders of Class A Common Stock have one vote per share and the holders of Class B Common Stock have ten votes per share. In addition, holders of Class A Common Stock, as a separate class, are entitled to elect 25% of all directors constituting the Board of Directors (rounded to the nearest whole number). As long as the Class B Common Stock represents at least 12.5% of the total outstanding Common Stock of both classes, holders of Class B Common Stock, as a separate class, are entitled to elect the remaining directors. The Company’s Articles of Incorporation and Bylaws provide that the Board of Directors can set the number of directors between five and eleven. Source: 10-k

Conclusion

IMKTA appears to be conducting ongoing renovation and expansion plan to add stores in its target markets. The company is making relevant capital expenditures, which could, in my view, bring not only economies of scale, but also net sales growth and free cash flow growth. In my opinion, the company’s long term expertise in the market, net income growth, and equity growth experienced in the last decade prove that IMKTA conducts a successful business model. I assumed that the know-how accumulated could bring substantial business growth in the future. I did not like that IMKTA appears to be a controlled entity. Besides, changes in the labor markets and increase in the interest rates could damage the company’s net income line. With that being said, in my view, IMKTA’s current valuation could be significantly higher considering the company’s FCF generation capacity and recent FCF growth.