Peter Rabover, CFA Artko Capital LP peter@artkocapital.com 1
Transcription
Peter Rabover, CFA Artko Capital LP peter@artkocapital.com 1
Peter Rabover, CFA Artko Capital LP peter@artkocapital.com Boring Is Beautiful: A Buy Recommendation on Village Super Market with a $55.00 Price Target Thesis: Village Super Market is one of the industry’s highest ROIC grocery chains with an incredible competitive advantage via its 13.4% ownership in a ShopRite Co-Op, Wakefern, a wholesale food distributor. Despite having consistent double digit ROICs the stock is trading at its 10-year lows on Price to Book (1.5x), EV to EBITDA (5.2x) and Price to Earnings (13.0x) as well as at a 40% discount to its worse performing peers. We believe the current valuation, the 3.8% dividend yield and the ownership in Wakefern create a significant margin of safety with less than 10% downside, while having a $55.00 3-year base case price target providing over a 100% return potential and a 28% annual IRR. Other catalysts include a decline in daily blind stock sales from the trust of one of the founders, an increase in the current dividend, an announcement of a special dividend and a potential transaction involving Wakefern to unlock its value. We believe Village’s stake in Wakefern is worth MORE THAN the entire current enterprise value of Village Supermarkets and a value unlocking transaction such as a tracking stock or a reverse merger by Wakefern could unlock significant value. With a long trading history Village has consistently traded between 1.4x and 2.3x book value, which is still significantly below its industry peers, and even a basic reversion to the mean strategy over the next 3 to 5 year period should yield a high teen IRR to the investor at the current price if no Wakefern transaction is to ever occur. Our goal in this write up is to highlight VLGEA as one of the top quality grocery operators versus its peers and that it deserves a higher valuation than being the lowest valued peer, as well as to highlight the true value of its ownership of Wakefern as a strategic asset and a financial one. We believe that Village already operates as a tracking stock for Wakefern and should trade appropriately. Business Description: Village Super Market, Inc. operates a chain of supermarkets in the United States. Its stores feature specialty departments, such as onsite bakery, an expanded delicatessen, natural and organic foods, ethnic and international foods, prepared foods, and pharmacies. As of July 25, 2015, the company operated 29 ShopRite supermarkets, including 18 in northern New Jersey, 8 in southern New Jersey, 2 in Maryland, and 1 in northeastern Pennsylvania. Village Super Market, Inc. was founded in 1933 and is based in Springfield, New Jersey. Additionally a company holds a 13.4% stake in a ShopRite Co-op, Wakefern. The company’s founding family, the Sumas family, which is comprised of seven people, owns 35% of outstanding shares and close to 70% of voting power. Their combined financial interest is over $130 million dollars. The estate of Perry Sumas, not affiliated with managing members, has been selling their $20 million stake at approximately 5% of daily volume for the last year, however those sales are expected to stop sometime in the next 12-18 months as the trust sells the last of their shares. Additionally, the family’s controlling B shares are structured that they receive only 65% of the dividends of the A shares. 1|Page Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com “Over the long term, it’s hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years, you’re not going to make much different than a 6% return – even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you’ll end up with a fine result. So the trick is getting into better businesses. If you can find a fairly priced great company and buy it and sit, that tends to work out very very well indeed.” – Charlie Munger, 1984 Background: In Charlie’s words we believe Village Super Market is that better business trading at a better than “fairly priced” price! Village boasts some of the highest and consistent ROICs/ROEs in the fairly simple grocery retail industry with an 8-year median and average return of 10.75% and a Free Cash Flow ROC median of 9.3%. The company’s returns go into compounding its book value at a 6% CAGR and paying out a $1.00 annual dividend with an average 2.5% to 5% dividend yield as well as occasional special dividends of an additional $1.00 per share. ROIC Comps 2|Page Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com Village Markets is able to achieve these fantastic returns by boasting some of the industry’s highest sales per gross square foot… … as well as having NEGATIVE working capital, with a 10 year median of -2.2% of Total Revenues. That means on average for every additional $1.00 in new revenues it generates, instead of investing working capital it actually generates $0.022 of additional free cash flow to the shareholders! As a result, free cash flow conversion is at an average of 3% of revenues or almost at 100% EBIT conversion and 165% of Net Income. So how is Village Super Market able to do that? Village Supermarkets belongs to and owns 13.4% of equity and debt of a ShopRite Cooperative, called Wakefern. Wakefern is New Jersey’s largest employer with over 70,000 employees and owns the NorthEast’s largest trucking fleet. As a strategic asset to Village, Wakefern is irreplaceable: *From the 10-k Filed 10.7.2015 “The principal benefits to the Company from its relationship with Wakefern are the use of the ShopRite name and trademark, volume purchasing, ShopRite private label products, distribution and warehousing economies of scale, ShopRite advertising and promotional programs (including the ShopRite Price Plus card) and the development of advanced retail technology. The Company believes that the ShopRite name is widely recognized by its customers and is a factor in their decisions about where to shop. ShopRite private label products accounted for approximately 9.7% of sales in fiscal 2015 . Wakefern distributes as a “patronage dividend” to each of its stockholders a share of substantially all of its earnings in proportion to the dollar volume of purchases by the stockholder from Wakefern during each fiscal year. While Wakefern has a substantial professional staff, it operates as a member owned cooperative. Executives of most members make contributions of time to the business of Wakefern. Executives of the Company spend a significant amount of their time working on various Wakefern committees, which oversee and direct Wakefern purchasing, merchandising and other programs. Nicholas Sumas, the Company’s Chief Marketing Officer, is a member of the Wakefern Board of Directors. Most of the Company’s advertising is developed and placed by Wakefern’s professional advertising staff. Wakefern is responsible for all television, radio and major newspaper advertisements. Wakefern bills its members using various formulas which allocate advertising costs in accordance with the estimated 3|Page Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com proportional benefits to each member from such advertising. The Company also places Wakefern developed materials with local newspapers. In addition, Wakefern and its affiliates provide the Company with other services including liability and property insurance, supplies, certain equipment purchasing, coupon processing, certain financial accounting applications, and retail technology support, including shoprite.com and the ShopRite smart phone app. The Company also has an investment of approximately 8.2% in Insure-Rite, Ltd., a Wakefern affiliated company that provides Village with liability and property insurance coverage.” Wakefern has 50 shareholder members, 323 stores, including 91 stores operated by Wakefern, and over 70,000 employees. As of September 25th, 2015, Wakefern won a $40 million bid for a package of 12 bankrupt A&P stores in the tristate area. Wakefern has a $15.7 billion in consolidated member revenue in FY 2015, a 6.8% revenue growth from 2014 and 4.3% growth from 2013 (more in Valuation Section). Wakefern is listed as a $26 million equity investment/asset on Village Marketplace’s balance sheet, with approximately another $43 million of Wakefern’s proportional debt on the balance sheet. In return Wakefern pays a “patronage dividend” that has grown at approximately at an 8.1% CAGR since 2008 as well as approximately a $2mm annual payment on the notes. With a total on the book investment of $69 million dollars, a $30mm annual cash payment for a 43% cash on cash return is not bad at all. Of course the true market value of this asset is significantly higher than the listed book value which we will explore in the valuation section. Wakefern Patronage Dividend (included in COGS) 7/31/08 7/31/09 7/31/10 7/31/11 7/31/12 7/31/13 7/31/14 7/31/15 $15.98 $16.78 $18.19 $17.72 $23.95 $24.78 $26.44 $27.56 The patronage dividend significantly increases Wakeferns ROE/ROIC (which are both equal due to approximately zero net debt at VLGEA) by at least 5%. However, this does not take into account the shared overhead costs, private label and advertising development as well as the negative working capital investment which is likely to increase the difference to at least another 2% or 3%. Financial and Operating Metrics and Forecasts Before we move on to a discussion of valuation we think it is important to note where Village stands in the industry with respect to various metrics, in addition to the aforementioned outstanding ROIC and Rev/PSQF. Revenue/Same Store Sales Village has grown its revenues at a 7-year CAGR of 5% driven by expansion in feet of 1-2% via acquiring 4 net stores, as well as expanding the square footage of its existing store base. As importantly, Village averages a pretty strong annual 2.7% same store sales median number, which as seen above is consistently above the industry medians/average. The last few years of revenues have been hurt by the Atlantic City economy as well as a number of casinos closing however going forward the company should be able to comp the low numbers higher as the New Jersey economic picture continues to improve rapidly. 4|Page Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com Since the annual numbers tend to be distorted by different fiscal year ends, we’ve analyzed the industry same store sales from a quarterly perspective where Village beat the industry medians over two thirds of the 30 quarters analyzed. 5|Page Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com Over the long term we expect for Village to continue to grow revenues in the historical 4% to 5% CAGR range. There are opportunities to expand more square footage from the current base as well as opportunistic store acquisitions and to continue to grow with the New Jersey economy and the industry. In the short term, the A&P bankruptcy and reorganization (stores bought by Acme Markets and Wakefern) should provide an additional tailwind to growth in the near term as the company grapples with restructuring. Gross and EBITDA Margins Village Super Market earns above the industry median’s gross margins and below median’s EBITDA margins, though we would note that Kroger’s successful strategy of investing in gross margin to drive same store sales makes margin comparisons across companies somewhat misleading and we still prefer ROIC as the ultimate arbiter of performance. 6|Page Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com More important to note here is that the Wakefern patronage dividend adds over 170 basis points of gross and EBITDA margins to Village Super Market’s operating performance. The Wakefern partnership likely adds significantly more to EBITDA margins due to the lower overhead shared costs for which Village pays a service fee to Wakefern. There is little reason to believe that the company won’t be able to keep up its average margins going forward. There are a few levers that it can pull to continue to at least maintain its historical margins: The store conversions, such as those in Morristown and Union, offer the ability to sell much higher margin products on pharmacies and Village Food Garden. The newly re-opened Morristown store even has a gym on the premises. The looming higher wages are a potential threat, however, management noted that even with the WalMart wage increase ShopRite still offers a more competitive wage and the New Jersey economy is still above the national unemployment rate. EBT, Taxes and EPS 7|Page Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com Village Super Market is one of the most underlevered public supermarket chains with its only debt $44 million of capitalized leases on 25 stores (out of 29) versus a cash balance of $59 million. The interest expense seems to be running at approximately 10% while the cash on deposit at Wakefern earns an average of prime plus .75%. In the end, and excluding the occasional income from a few small real estate LPs the company participates in, the net interest expense runs at approximately $1 to $2 million dollars. We should also note that Village has a $32 million PBO ($83 million in liabilities versus $51 million in assets) that does not use aggressive assumptions with a ~4.0% discount rate and a 7.5% assumption on ROR on plan assets. After having settled all matters in the New Jersey tax litigation, the company should continue to have a 41% to 42% tax rate. As mentioned earlier, Village has two classes of shares. The B shares, of which there are 4.4 million outstanding or 31% of the total, receive 65% of the EPS and dividends of the A shares (though same economic benefits in a liquidation). Between 2011 and 2013 there was a conversion of 2 million shares from B to A which created a headwind for A share EPS (among other headwinds). While the company has a nominal $5 million share buyback outstanding we do anticipate an eventual conversion of B shares to A shares by the Sumas family as the 2nd generation is replaced by the 3rd generation and some of the family’s trusts (such as the Perry Sumas trust) could begin to liquidate on the public or private markets. A full conversion would represent a 12% headwind to A share EPS. While the company’s A shares on EPS basis have been relatively flat over the last few years hampered by lower same store sales and Atlantic City economy, less operating margin leverage and the New Jersey tax settlement, over the long term, and unlikely in a linear fashion, we expect the company to grow its EPS in high single/low double digit CAGR rates as the company gets back to its historical growth and margin rates. While we appreciate and share the concern of lack of underperformance in EPS, we are more impressed with the high ROEs, Free Cash Flow generation and cash on cash returns by Village Super Market. The cash has gone on to investing in growth square footage expansion, paying out a 3% to 5% dividend yield as well as paying out three special dividends since 2008. Free Cash Flow and FCF Return on Capital EBIT (1-t) Depreciation Maintanence CapEx Changes in WC Free Cash Flow Free Cash Flow as % of Revenues Free Cash Flow as % of EBIT Free Cash Flow as % of NI 7/31/08 $22.52 $13.71 -$13.90 $8.24 $30.57 2.71% 78.89% 135.59% 7/31/09 $37.98 $15.32 -$15.67 -$14.66 $22.96 1.90% 48.28% 84.25% 7/31/10 $37.34 $16.90 -$16.85 $8.27 $45.67 3.62% 100.90% 179.92% 7/31/11 $34.24 $18.62 -$17.75 $19.09 $54.19 4.17% 141.43% 258.28% 7/31/12 $45.60 $19.76 -$18.62 -$15.96 $30.78 2.16% 55.41% 97.90% 7/31/13 $39.72 $20.35 -$19.83 -$16.30 $23.95 1.62% 54.21% 92.89% 7/31/14 $32.01 $22.27 -$22.18 $45.01 $77.12 5.08% 258.54% 304.04% 7/31/15 $40.52 $23.33 -$23.53 -$41.28 -$0.96 -0.06% -2.21% -3.97% 7/31/16 $42.67 $23.88 -$23.88 $17.84 $60.52 3.67% 123.35% 217.50% 7/31/17 $46.27 $24.84 -$24.84 $1.45 $47.72 2.79% 87.95% 154.91% 7/31/18 $50.12 $25.83 -$25.83 $1.51 $51.62 2.90% 86.27% 151.27% 7/31/19 $54.22 $26.87 -$26.87 $1.57 $55.79 3.01% 84.76% 148.27% 7/31/20 $58.60 $27.94 -$27.94 $1.63 $60.23 3.13% 83.39% 145.56% WC WC as % Revenues Maintanence CapEx as % of Revenues Gross PPE Goodwill Wakefern Equity Investment Wakefern Debt Investment Other Assets -$34.22 -3.03% -1.23% $272.60 $10.61 $18.29 $31.12 $4.57 -$19.56 -1.62% -1.30% $307.29 $10.61 $19.67 $16.98 $4.73 -$27.83 -2.21% -1.34% $330.43 $10.61 $20.26 $18.20 $6.89 -$46.91 -3.61% -1.37% $348.13 $10.61 $22.46 $19.51 $6.75 -$30.96 -2.18% -1.31% $365.05 $12.06 $23.41 -$59.67 -3.93% -1.46% $434.91 $12.06 $25.01 $40.60 $10.24 -$18.39 -1.16% -1.49% $449.69 $12.06 $25.75 $41.42 $12.17 -$36.24 -2.2% 1.45% -$37.69 -2.2% 1.45% -$39.19 -2.2% 1.45% -$40.76 -2.2% 1.45% -$42.39 -2.2% 1.45% $30.08 -$14.66 -0.99% -1.34% $388.76 $12.06 $24.36 $0.00 $8.66 Total Capital Average Capital $302.98 $289.73 $339.72 $321.35 $358.57 $349.14 $360.54 $359.55 $399.63 $380.08 $419.17 $409.40 $463.14 $441.15 $522.69 $492.92 FCF ROIC 10.55% 7.15% 13.08% 15.07% 8.10% 5.85% 17.48% -0.19% 9.32% <-- Median 8|Page Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com Valuation – Price Target: $55.00 We hope we have sufficiently highlighted the quality operating performance by Village Super Market relative to its peers to show that in our base case it at least deserves industry median valuations as a combined VLGEA/Wakefern company and should revert back to its historical and industry multiples in the intermediate future while paying out consistent dividends as well as special dividends. Additionally, our goal here is to highlight the value of Village’s stake in Wakefern on a Sum of Parts valuation and to show that realistically VLGEA should trade as a tracking stock for Wakefern with a small New Jersey retail operation on the side. Base Case Valuation 1: Historical growth, reversion to historical and industry medians – 3 year PT: $55.00 In our base case, as highlighted in the financial forecasts above, we expect the following results for the calendar year* 2016, 2017, and 2018 based on below historical revenue CAGR of 4%, revenue growth of 4% (driven by guided SSS of 1-3% and square footage growth from recently completed conversions) and continued historical margin performance as well as an 8.1% growth from Wakefern: o EPS of $2.28, $2.50 and $2.76 o EBITDA of $76.0, $82.4 and $89.2 million o Book Value Per Share of $19.16, 20.15 and $21.82 *we chose calendar years to make results more comparable to peers as VLGEA’s FYE is typically the end of July Over the last 8 years, or via the last economic cycle, Village has traded over 18.0x TTM EPS 5 times and over 2.2x Book Value 7 times. We believe that in the next 3 years Village Supermarkets should revert to its historical fundamental valuation ranges for a 2018 P/E Based Price of ~$50.00 and a 2018 P/BV based price of $48.00 at 18.0x and 2.2x times. This does not include 3 years’ worth of dividends at $3.60 (not linear) as well as well as a potential special dividend for another $1.50 due to VLGEA having currently over $4.00 per share of cash on its balance sheet. We expect an announcement after the upcoming December 2015 Board of Directors Meeting. 9|Page Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com As we did with the operating metrics we compiled an industry comp table. As we noted earlier, VLGEA is the lowest valued member of the group despite having many superior metrics and the cleanest balance sheet when compared to the non-specialty grocery group. However, we would caution that the Enterprise Values, while adjusted for Pension Liabilities are not adjusted for Operating Leases. Village’s $32 million pension liability is added to its EV. We can see that on almost all metrics VLGEA is the lowest valued peer even when compared to such strong underperformers like Roundys (bought out by Kroger on November 10th), Ingles Markets, SuperValu and Fairway Group Holdings despite having almost no leverage. We will acknowledge that having strong management ownership is a double edged sword with strong incentives to create value as well as a habit not to “rock the boat” via accretive but risky transactions and VLGEA should not be immune to having a slight minority shareholder discount. However we will note that, VLGEA trades below even Weis Markets, a family controlled North-East supermarket chain, that hasn’t even been able to file its annual report due to material weakness and high uncertainty surrounding the recent death of its founder. Other deal multiple considerations: Roundy’s was bought out by Kroger at approximately 7.0x TTM EBITDA with negative growth EBITDA and having 80% leverage. The Safeway deal was 6.5x TTM declining EBITDA with at least 30% Debt. While it’s not easy to justify 2018 multiples based on today’s prices, we can clearly see that VLGEA is undervalued relative to its non-specialty peers despite having a superior balance sheet and returns and we are ok with using 2015 multiples on 2018 for a 3 year price target as we hope with a time frame that long the market should recognize Village Super Market’s superior performance and adjust accordingly. o On 2018 EPS of $2.76 the Price Target is $~50.00 using an 18.0x multiple o On 2018 EV/EBITDA multiple of 7.6x the Price Target is $46.50 o On 2018 P/BV multiple of 2.5x the Price Target is $54.50 Using the industry and historical comparisons our CYE 2018 blended Price Target is $55.00 using an average price of $50.00 and an additional $5.00 in dividends during the forecasted investment period 10 | P a g e Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com Base Case Valuation 2: Sum of Parts Caveats: This is a purely hypothetical exercise to highlight the value of Wakefern. A) It’s probably unwise to expect any transactions in the intermediate future. While not impossible, it’s improbable. B) The valuation is based on limited public information: Revenues reported by Wakefern and patronage dividends reported by Village and their ownership interest. C) The two entities are synergetic in that one’s value is dependent on the other so it may not be wise to consider them as standalone entities. D) This entire process is more art than science and there may not be a correct way to value Wakefern and its value on the VLGEA balance sheet As we’ve seen in the Financials section, by adjusting the operating performance of Village Super Market for ex-Wakefern’s dividend, the company’s margins and ROEs are significantly lowered to midsingle digits and the bottom of the industry performance metrics. This analysis also does not take into the account the reduced purchasing power and higher overhead that Village would incur if it were not part of the Co-Op. While this is a purely hypothetical analysis, a book value that doesn’t grow and may even decline at ~$10.00 and EPS at ~$.80 are likely to deserve very low multiples, on par with SuperValu. A 10x P/E and a .8x BV would result in an $8.00 per share valuation of VLGEA ex Wakefern’s contribution. On the other hand Wakefern is a $15.7 billion revenue firm with $200 million in earnings growing at 6% and 10% CAGRs, respectively. Wakefern has a Wholesale and Retail business of serving 232 members including Village’s 29 locations and Gristede’s 31 locations in Westchester County, NY and New York City, as well as operating 91 retail stores. Additionally, Wakefern just purchased 12 more retail stores in the A&P bankruptcy sale. *Wakefern has ambiguous language when putting out revenue numbers. For example: “The company reported a record retail sales level of $15.7 billion for the 53week fiscal year ending October 3, 2015, a 6.7 percent increase from the prior year, and $12.8 billion in Wakefern wholesale sales.” We do not interpret those to mean as two separate streams as it would be hard to believe Wakefern’s 91 retail locations generated $15.7 in retail sales. However, this does show the additional difficulty of using this information to value Wakefern. 11 | P a g e Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com There are not a lot perfect public wholesale food distributors but we’ve identified 5 which we think are at least somewhat comparable to Wakefern: United Natural Foods, Spartan Nash, Performance Group Holding, Core-Mark Holding and Amcon Distributing. Of the five we believe that Spartan Nash and United Natural Foods are the likeliest comparables given their profile of also having a wholesale/retail operational mix, size in ~$8 billion in revenues, comparable Net Income margins and mid-single digit Revenue CAGRs. We also do not know the capital structure of Wakefern but a guestimate of Wakefern’s proportional debt of $43 million on Village’s balance sheet at 13.4% can get us to approximately $300 million in debt. Looking at the comps below and in the Base Case 1 we came up with 2 scenarios: Low and High: In the Low scenario, VLGEA is valued at $8.00 with 0.8x B/V and 10x Earnings. Wakefern is valued at 0.2x Revenues, 12.0x Earnings or 6% dividend yield (since it does not reinvest the earnings back into the company). The average price for Wakefern is $27.00 and the Low Case Sum of Parts Valuation for the entire VLGEA is $35.00 or 35% above today’s price. In the High scenario, VLGEA is valued at $13.00 with 1.3x Book Value and 13.0x Earnings based values. Wakefern is valued closer to retail peers and United Natural Foods at 0.4x Revenue, 18.0x Earnings or a 2% dividend yield. The average price for Wakefern is $61.50 and the High Case Sum of Parts Valuation for the entire VLGEA is $74.50 or almost 200% above today’s price. 12 | P a g e Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com The likely Sum of Parts Valuation is somewhere between those two sides around $55.00. And while a value unlocking transaction may never happen this exercise serves two purposes: To show that VLGEA should actually be viewed as a tracking stock for Wakefern as it is the more valuable asset in the company and to show that Village’s ownership of Wakefern provides a significant Margin of Safety. Downside Case – Price Target $23.32 with VLGEA price of $20.25 and $3.07 in dividends; loss -12.5% In our downside case the book value barely grows over 3 years on low revenue growth, declining margins and the company essentially trading at a flat 5% dividend yield. We are of the opinion that in underperforming case scenarios stocks trade on their book and asset values rather than earnings and VLGEA’s lowest book value comp in the last 10 years has been 1.1x. The last time the company dropped below 1.0x book value was in September 2000. We are comfortable assigning a 1.1x multiple on an essentially flat book value and taking the risk of permanent capital loss in low double digits. Upside Case – Price Target $90.00 with VLGEA price of $85.00 and $5.00 in dividends; return -240.00% In our upside case the earnings per share grow at high teen rates over 3 years on 6% revenue growth, expanding EBITDA margins and the company’s multiples adjusting to the high growth specialty grocery comps. The probability of this scenario happening is low, but growing square footage via an acquisition, getting a few years of high same store sales and leveraging the fixed cost SG&A while the Wakefern dividend grows at 10% is not out of the realm of possibilities. 13 | P a g e Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com LBO Analysis - Price Target of $45.00/70% Buyout Premium from today’s price As a final valuation exercise we ran an LBO analysis to see what a Private Equity or a strategic buyer could get for the company if the family ever decided to sell (the least likely scenario). At an 8.5x unadjusted EBITDA multiple/$45.00 price and a 70% premium, an LBO buyer should be able to achieve 30-40% IRRs/4.0x Multiple on Invested Capital at a 75/25 Debt/Equity Mix. Additionally, this analysis also includes an assumption of a $50 million run rate of SG&A cuts/synergies. 14 | P a g e Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21 Peter Rabover, CFA Artko Capital LP peter@artkocapital.com Risks/Concerns One of the biggest risks with this investment is the added degree of uncertainty due to low disclosure. The company has very little shareholder communication and doesn’t hold earnings calls. Additionally, with the changing of management from the 2nd generation of the Sumas family to the 3rd generation adds more uncertainty to the firm’s future as the management has not communicated to the shareholders their intentions. Finally, with so much of the value dependent on Wakefern, it is slightly disconcerting about having such little information about that asset. Having said that, the low valuation and the family’s history of successfully growing the firm over decades gives an added degree of comfort. Most family members it seems have worked in the company their whole lives and their significant stake of over $130 million dollars surely creates a powerful incentive to grow the firm and concentrate on preservation of capital. The industry is facing some headwinds in the form of labor wage growth and food deflation. Village Supermarkets is heavily concentrated in New Jersey which ranked 46th in GSP growth in 2014 with only a 0.4% growth, hampered by the economic troubles in Atlantic City and casino closures. Having said that, New Jersey’s unemployment rate closed 90 basis points to 5.6% in the last 6 months and the lower energy prices are creating some tailwinds for the shopper. Additionally, New Jersey ranks 5th in having the lowest poverty rate (10.8%) and 3rd highest in having disposable income at $46,778 creating a strong addressable market for higher priced products. Competition, competition, competition – It comes in all forms from Wal-Mart, Target, dining out, Amazon Fresh, and other growing food delivery options. This is a risk we are likely to be watching closely as technology has a way of disrupting even the most stable of businesses. Village Supermarkets is not standing idly by and has the “Shop At Home” option at 14 out of 29 of its stores representing slightly less than 5% of the revenues. Additionally, we did an informal survey of approximately 20 people (not solid enough to put in the thesis but solid enough to give comfort in risk assessments) where the average assessment of the New Jersey ShopRite experience was 9 out of 10 and price satisfaction was 7.3 out 10. The microcap stock has round tripped over the last 5 years (though the return was still positive given the special dividends) and the price has generally been unpredictable. The uncertainty factor is high, and while the low valuation and dividends will likely limit any capital losses. Irrational price volatility and low liquidity factors should be carefully considered prior to investment. Final Disclosure: We are shareholders of Village Supermarket and are obviously incentivized to highlight the positives of the stock and the company. 15 | P a g e Downloaded from www.hvst.com by IP address 78.47.27.170 on 2016/10/21