Village Super Market VLGEA

1
Village Super Market (VLGEA)

• Sell Pitch
• February 25th
• By James Cullen

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Some Resources

• http//collegeanalysts.com/?page_id246
• SEC Filings
• Financials
• Historical Valuation
• Wide Moat Companies
• Video About USG

3
Background

• We own 400 shares of VLGEA, purchased at 13.57
  in September 2003
• The stock closed Friday at 44.65, for a total
  gain of 230
• VLGEA is currently the portfolios single largest
  holding (about 5.7)

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The Gameplan

• Use limit orders to create a collar
• Enter a stop loss at 44.00
• Enter a limit sell at 46.00
• Volume in VLGEA is light, typically less than
  5,000 shares trade per day
• A 400 share market sell would otherwise incur
  significant transaction costs

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What Does Village Do?

• Operates 23 ShopRite supermarkets with 2 new
  store locations under construction
• Two dozen locations throughout New Jersey and one
  in NE Pennsylvania
• Focuses on superstore approach
• These are higher margin items
• Bakery
• Pharmacy
• Prepared Food

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Why We Should Sell

• Inherently Poor Business Economics
• Company-Specific Issues
• Reasonable Selling Price
• Raise Cash for Portfolio
• Further, since our store base is concentrated
  in densely populated metropolitan areas,
  opportunities for future store expansion may be
  limited

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Why Poor Economics?

• Products Largely Commodity-Based
• Price takers
• Ultra-low Margins
• Need High Inventory Turns
• Real same-store sales growth
• Working Capital Intensive
• In two words No Moat

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What is a Moat?

• Sustainable trait that allows a company to earn
  above-average returns on capital (i.e. create
  value) over a long time period
• Incomparable economy of scale
• Network effects
• Intellectual property rights
• High switching costs
• Supermarkets have none of these

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Industry/Sector Comps

• Fourth lowest margins in a sector (services) with
  the second lowest margins of all types of
  businesses

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Everyone Following?

• I want to make sure everyone understands the
  underlying business economics as well as the
  concept of a moat because doing so is crucial
  to understanding why we should sell VLGEA
• Any quick questions on what weve covered so far?

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How Do Supermarkets Make Money?

• Need to leverage economies of scale on gross
  margin, operating expense
• Can Village find/exploit further efficiencies?
• I dont see it happening
• Wakefern for inventory purchases
• Leveraging operating costs/SGA
• Increase customer volume at stores to drive more
  (quicker) inventory turns
• Can NJ get any more crowded?

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The Net Margin QuestionPeaking, or Room for
Expansion?
I give management credit - margins have more than
tripled in the last 10 years but where to from
here?
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The Net Margin Question

• Village already purchases substantially all
  inventory through Wakefern, a co-op
• Wakefern allows all ShopRites to combine
  purchasing power
• Operating leverage requires store growth without
  matching increases in SGA
• Store growth and selling sq. footage has
  essentially been constant
• 2 net margin is top-end of industry range
• Arden (ARDNA) and GAP arent really special

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S-S Comps Growth vs. Cost Pressures

• The other key component of supermarket
  profitability is high inventory turnover, which
  requires growing same-store sales
• I believe that recent S-S comps growth is not
  organic, but due to cost inflation
• Sales growth was 4.8, with 3.6 s-s (mrq)
• But, COGS was up 5
• Massive inflation in food prices that almost
  makes BCDS prices look reasonable

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Marginal Return on Capital

• We already know the supermarket industry is less
  than ideal for investment
• But Village has historically done a pretty good
  job at driving ROMIC while the company is growing
  (about 10)
• I believe saturation and food cost inflation is
  going to pressure ROMIC
• More money tied up in inventory where prices in
  excess of costs cannot be passed along will weigh
  on ROMIC going forward

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End Markets NJ and East PA
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Time to Sell Reposition Portfolio

• Supermarkets are not the kind of industry we want
  to invest in
• Difficult to see Village improving from present
  state
• Lock in a good return
• Portfolios cash balance is low

Earnings from a stable company will tend to be
most highly valued in difficult times, i.e.
now VLGEA has little growth potential, but trades
at 14x earnings
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Closing Questions?

• Ask away