Spruce Point Short Weis Markets (WMK)Guest Post
Spruce Point Capital Management is pleased to announce it has released the contents of a unique research report on Weis Markets, Inc. (NYSE: WMK) (“Weis” or “the Company”) with a “Strong Sell” opinion and a $17.60 – $26.40 price target, or 45% – 65% downside risk. Spruce Point has spent months conducting a critical forensic and fundamental analysis of the Company, a regional supermarket facing intense pressures from disruptive low cost competitors.
Based on our analysis, we provide compelling evidence that Weis is obfuscating its financial pressures with aggressive accounting and reduced disclosures that will make its recent share price performance unsustainable. Weis is currently the highest valued supermarket in the stock market, despite negative organic growth, declining gross and EBITDA margins, among the worst returns on capital in the industry, poor governance, and limited information provided by management. As a result, we see up to 45% to 65% downside in its shares.
Key Highlights of Our Investigative Forensic Research Report Include:
With the entry of Amazon into the supermarket space through the Whole Foods acquisition, as well as low cost competition (Aldi, Lidl, WalMart, Target, etc), we believe Weis is poorly positioned to adapt to the changing landscape
- We conducted price checks and find that Weis’ prices for a basket of grocery items are 15% higher than peers (they were 20% higher last year, but Weis has generally lowered prices). Convenience, followed by price, are the two main factors drawing shoppers to the local supermarket according to a recent NGA poll. In our opinion, Weis fares poorly on both
- With the help of Big Data analysis from Earnest Research, we investigated shopping patterns among 42,000 Weis customers using credit and debit card transactions. The data suggests that for the past three quarters, Weis’ unique shoppers, average transactions per shopper and total transactions per shopper are in YoY decline, and that low cost competitors such as Aldi and Lidl are having a measurable impact on Weis' customer behavior
Weis turned to acquisitions in 2016 during a period it suspended many SSS metrics and went through three different auditors between 2014-2016.
- Weis claims 2017 sales growth was “primarily” from acquisitions. However, our analysis disproves this statement, and shows that core grocery and pharmacy sales declined by 1.1%
- Weis posted a Q2’18 negative SSS comp of -0.7% (ex: fuel) and blamed part of the decline on the timing of July 4th. It also inflated its Q2 comp by including $12.5m of estimated July 4th sales that should have been in Q3’18
- The last time Weis ever mentioned July 4th in its SEC filings was in 2001 (17yrs ago)
Weis “Growth Plan” Is Not What It Appears
- In April 2018, Weis announced a new $101m capex plan to invest in growth. The press release disclosed Weis would open two new stores
- Weis did not disclose to investors that it would close three stores, resulting in unit stores declining by 1 in 2018
- We believe most of the capex is going towards maintenance improvements and not towards growth
- Weis has been cited regulators for potential contamination and pest control problems by the FDA (produced through a FOIA) and The Pennsylvania Dept of Agriculture Inspection reports. Weis has had four product recalls in the past year for labeling control issues
Aggressive accounting change temporarily inflating the appearance of operating cash flow growth
- In May 2018 with the filing of the Q1’18 10-Q, Weis disclosed that as of 12/31/17 it adopted a policy to consider funds-in-transit up to 7 days as “cash equivalents” thereby accelerating operating cash flow and improving its cash conversion metrics
- Based on our industry research, we believe up to 7 days is a very aggressive interpretation, with most supermarkets considering no more than a few days
- On the surface due to the accounting change, Weis reported Q1’18 YoY operating cash flow growth of 550%, however based on our adjustments the growth was 74% and off a temporarily depressed level
- Q2’18 operating cash flow declined 40%
- We expect Weis to have difficulty showing operating cash flow growth going forward as it laps the anniversary of the accounting change and big data performance insights show continued weakness
Governance and Shareholder Unfriendly Policies
- Weis claimed “financial and operational success” in 2017 despite reporting its lowest gross and EBITDA margins, having negative underlying organic sales growth, and posting the second lowest Return on Investment Capital in the supermarket industry. The compensation committee gave key executives double digit salary increases
- There is virtually no alignment among rank and file management and employees with shareholders. Employees own a collective 17,604 shares or less than $1m of Weis stock
- Weis makes use of a corporate jet, despite all of its supermarkets being within a few hour drive of headquarters
We see 45% to 65% Downside Risk
- Weis trades at the highest valuation in the supermarket industry and its share are up 12.5% YTD, for no obvious reason, and with mounting evidence its business is now in decline
- Our analysis illustrates that Weis sales started to decline organically in 2017, pressures are intensifying in 2018, and aggressive accounting is being used to temporarily inflate results
- Furthermore, Weis took a one-time benefit in Q4’17 for the tax reform that will be a headwind to lap in the coming quarters
- Weis reports among the industry’s worst return on invested capital, gross profit per employee and square foot, and sales per employee
- Weis’s current valuation is higher than industry takeover premiums implied from recent regional supermarket acquisitions
- Given the high fixed cost operating leveage in supermarkets, we believe its low single digit revenue declines in 2018 will result in a 19% decline in Weis earnigns this year
- By applying a 12x to 18x multiple of our estimated 2018E EPS of $1.47, we believe Weis shares to be worth approximately $17.60 to $26.50 per share
Spruce Point Believes Weis Markets (NYSE: WMK) Is A “Strong Sell” With 45% - 65% Downside Risk
Weis Markets, Inc. (NYSE: WMK or “the Company”) is a regional supermarket that is poorly positioned amidst an intensifying competitive environment. With shares hitting both a 52 week high and low in the last year, we conducted a forensic and fundamental review.
A Poorly Positioned Supermarket In An Increasingly Competitive Space:
- Not Aligned With Mega-Trends Affecting Supermarkets: We analyze key supermarket mega-trends and find Weis to be poorly positioned.
- Cannot Compete On Price According To Our Proprietary Price Checks: We conducted price comparisons on a basket of staple food products. Weis’ prices were at a +19.7% premium to peers in 2017 vs. +15.6% premium in 2018. Weis is cutting prices and experiencing margin pressure. Convenience, followed by price, are the two main factors drawing shoppers to the local supermarket according to a recent NGA poll. Weis fares poorly on both.
- Numerous Sanitary, Pest Control Problems and Labeling Issues: An FDA FOIA shows issues with dead mice at Weis’ main distribution warehouse, and over 200 state inspection violations YTD in Pennsylvania. Multiple product recalls logged at the FDA suggest labelling and product control problems.
Evidence of Financial Strain Uncovered By Spruce Point Forensic Analysis:
- Evidence of Negative Organic Revenue Growth Being Obfuscated By Management: In 2016, Weis turned to growth by acquisitions, acquiring 5 Mars Super Markets, 38 Red Lions, and Nell’s Family Market. In the same period, Weis systematically stopped providing disclosures about same-store sales metrics across product categories. Weis says growth in 2017 was “primarily” by acquisitions. However, our analysis disproves this statement. Absent acquisitions, revenues decline by -0.5%. By further excluding fuel sales, core grocery and pharmacy sales declined by -1.1%.
- Big Data Insights Validate Concerns: Spruce Point gleaned insights from Earnest Research on credit card panel data to investigate further. Recent quarterly data show a concerning trend of declines in unique shoppers, total transactions, and average transaction per shopper. Weis has been able to partially offset these declines with growth in average transaction size per customer, but recent data shows this metric slowing too. We also provide compelling evidence to show Weis has poor customer retention relative to grocery peers, and is likely losing customers to low cost leaders such as Aldi
- Gross And Operating Profit Under Pressure, Now Accounting Changes Made: Gross and operating margins are key performance metrics for supermarkets. In 2017, gross and operating margins tumbled to near an all-time low of 26.7% and 4.6%, respectively. Management blamed it on the weather, but we believe structural and competitive issues are the true underlying cause. Weis has also dramatically reduced operating costs disclosures, despite an SEC comment letter asking for greater cost detail. Spruce Point often finds companies under pressure make accounting changes to mask results. Not surprisingly, in Q1’18 Weis disclosed that it changed its accounting policy for cooperative advertising costs. As a result, it reclassified costs from operating, general and administrative expenses to cost of sales to lower gross margins. This allows Weis to deflect core margin declines.
- Aggressive Accounting Change Artificially And Temporarily Inflates Operating Cash Flow: On the surface, Weis’ Q1’18 cash from operations looks impressive with 550% YoY growth. However, we find it moved accounts receivables to cash claiming that funds in transit under 7 days are cash equivalents. Based on our industry research, we disagree and believe its interpretation is very aggressive. Our pro forma analysis suggests that operating cash flow grew 74% YoY, substantially less than 550%. While on the surface impressive, the growth was further aided by depressed results in early 2017 from its acquisitions. We expect future cash flow comparisons to become significantly more difficult. In Q2’18, cash flow declined 40% YoY
Shareholder Unfriendly Policies And Governance Concerns:
- Insider Buying Ahead of Accounting Change: Our worries about financial accounting gamesmanship are heightened by the fact that that the CEO/Chairman purchased stock for the first time ever in Nov 2017 ahead of making the questionable accounting changes in Dec 2017.
- Auditor Turnover: As a cautionary sign, Weis is on its third auditor in just 4 years. E&Y has served as the auditor twice. In its last stint, E&Y was dismissed in 2016 after just 2 years (same year product level SSS metrics were suspended). E&Y’s first time as auditor it chose not to be reappointed.
- No Conference Calls: Weis provides little descriptive details of its earnings in press releases and doesn’t hold conference calls. Furthermore, in our opinion, quarterly Management’s Discussion and Analysis (MD&A) in SEC filings are insufficient to fully understand Weis’ financial performance.
- Run For The Benefit of Insiders: The Weis family controls the Company and uses NYSE governance exemptions to create a weak Board of just 5 members (3 are “independent”) that can rubber stamp the Chairman and CEOs directives. For example, despite 2017 being the worst year in recent history, the compensation committee claimed 2017 was a “success” and approved a 10% and 15% salary raise to the CEO and CFO, respectively. Executives also use a corporate jet despite the fact that most supermarkets are within a few hours drive of company headquarters.
- A Deliberate Non-Equity Culture: Weis states bluntly that “The Compensation Committee does not believe that equity-based incentives are a valuable incentive for employees of the Company“. As a result, the entire executive team and Board (ex: Chairman/CEO Weis) own a laughable 17,604 shares (approx. $1m). Furthermore, there are no equity or option programs for rank and file employees to incentivize value creation.
The Most Expensive Supermarket In America Relative To Declining Growth And Poor Positioning, We See 45%-65% Downside Risk:
- Benchmark Analysis Illustrates A Suboptimal Company: We compare key financial metrics relative to other regional chains and find below avg results.
- Recent Financial Performance Unsustainable: The entire “earnings upside” in 2017 came from a one-time tax benefit and recent gimmicks used to optically improve operating cash flow – neither of which are sustainable and will create difficult year-over-year comparisons.
- New Capital “Growth” Plan Appears Deceptive, Won’t Move The Needle: In April 2018, Weis announced a plan to invest $101m in growth, including two new store openings. However, it failed to disclose it is closing three stores! The majority of the $ is for store remodels, supply chain improvements + IT upgrades - sorely needed to remain competitive. In other words, capital is directed toward maintenance and not store growth.
- Trading At Irrational Premium To Recent Takeover Multiples: Our analysis of recent regional supermarket takeout premiums suggest Weis would be fully valued at 0.3x, 6.4x and 19.0x estimated sales, EBITDA and P/E. Weis trades at 0.3x, 7.6x and 32.0x for a subpar industry player with below average margins. Weis reminds us of Tootsie Roll which was also trading at an irrational premium to its takeover value. Tootsie subsequently declined ~25%.
- Lack of Research Coverage To Say “Sell”: Weis has no analysts that cover its story, but we’ve followed it carefully and believe there’s nothing but downside. We expect margins to continue to contract as Weis is faced with reality that it must be more price competitive to survive. Valuing Weis at a discount to peers to reflect its weak disclosures and financial profile, poor market position and governance, we estimate 45%-65% downside risk.
Weis’ Capital Structure And Valuation
In our opinion, Weis Markets is a regional supermarket with limited differentiation from peers and struggling to adopt to the changing environment. The Company holds no conference calls, has questionable financial statements, and unsustainable financial performance given aggressive and recent accounting changes made at year end 2017. Weis has the highest valuation in the supermarket sector despite declining organic growth and margins, poor return on capital, and is trading well above recent takeover premiums in the supermarket sector.
Read the full article here by Spruce Point Capital Management