Ingles Markets: A Stock Pitch

“So long as you have food in your mouth, you have solved all questions for the time being.”
Franz Kafka

SHARE PRICE: $61.00 BOOK VALUE: $82.00

MARKET CAP: $1.2 Billion NORMALIZED EPS: $7.00/sh

ENTERPRISE VALUE: $1.5 Billion NORMALIZED EBITDA: $320 Million

THESIS

·         Ingles Markets’ rural focus, geographic density and real estate ownership help insulate it from competitors.

·         Post Hurricane Helene, it trades at a depressed valuation (25% below book value), a 40% discount to its 10-year average. It also trades at a discount to peers, despite superior margins and returns on invested capital.

·         While results are weak due to inflation, negative sales growth and depressed margins, historically these tend to normalize.

·         It has substantial non-core real estate which I estimate is worth $25-30/share.

·         The company’s balance sheet provides significant optionality and I suspect a buyback may be forthcoming.

THE BUSINESS: Ingles Markets is a supermarket chain in Asheville, North Carolina. Their 198 stores average 57,000 square feet and serve smaller communities (less than 100,000) within a day’s drive of their distribution center, primarily Georgia and the Carolinas. It was founded by Robert Ingle in 1965, went public in 1987 and is controlled by his son, Bobby Ingle, via 73% voting and 23% economic control.

THE INDUSTRY: Food retail is known for two things: slim margins and fierce competition. Walmart captures almost a third of all sales and their everyday low prices keep the industry honest. Costco has grown food sales by almost $100 billion in the past decade, harnessing its substantial purchasing power to attract more members. Under Amazon’s ownership, Whole Foods has best-in-breed technology, logistics and data. Ask me three companies I’d rather not compete with and Walmart, Costco and Amazon all come to mind.

Traditional supermarkets like Kroger, Publix and Albertsons are struggling to stay relevant as formats have multiplied (club store, mass merchant, supermarket, small format, discounter). Low growth and high competition encourages consolidation, the rationale behind Kroger’s recent attempt to acquire Albertsons. Gone are the days when the local supermarket could rely on capturing 100% of our food budget from a single weekly trip. As consumers, we’re spoiled for choice by format, distribution method, ticket size and merchandise mix. Like much of retail, it’s the definition of a fragmented industry.

That being said, grocers are notoriously hard to kill. They typically increase square footage 1-2% a year and grow same store sales a little above inflation. The pandemic upended the industry as restaurant closures tilted consumption towards meals at home and supply chain disruptions led to stockpiling. Excessive savings and stimulus increased consumers’ buying power (SNAP benefits doubled from 2019 to 2022), so a business not known for pricing power suddenly found some. Many grocers grew sales three to four times normal.

It's been said that high prices cure high prices. This demand surge led to the highest food inflation in a generation, peaking at 13.5% 2022. This ultimately resulted in demand destruction as low-end customers struggled to afford essentials, packaged food companies began reporting negative volumes and SNAP benefits were meaningfully curtailed. This led Ingles to report its second ever sales decline in 2024.

HURRICANE HELENE: Hurricane Helene made landfall in Western North Carolina on September 27th, 2024, the day before Ingles’ fiscal year end. The company delayed its annual filing, lost power at 80 stores, and suffered $35 million of spoilage and property damage. In less than a week, the stock slid 19%. The next quarter they reported $60-$80 million of lost sales from store closure and electronic payment disruption. While recovery efforts are ongoing, few institutions are more essential than a small-town grocer and all but three stores have reopened.

THE MODEL: Grocers have long been in the real estate business. They seek out convenient locations with attractive demographics and rising incomes. The more traffic they generate, the more vendor allowances they can extract from packaged food companies. As anchor tenants, they receive favorable terms from developers who rely on their traffic to increase adjacent rents. Amongst public grocers, six own some percentage of their real estate (typically less than 50%) while smaller formats prefer to lease. Ingles Markets is unique in that it owns 175 of its 198 stores.  

Real estate ownership is capital intensive. If a landlord is willing to finance your property at a lower cost of capital, it’s tempting to let him. But leases are basically debt, swapping a capital expense today for overhead tomorrow. Typically lasting 20 years, they often contain rent escalators and revenue sharing arrangements so landlords can participate in the upside. Rents are a function of interest rates, and when rates were low, developers were accommodating. Today, not so much. Usually priced at a spread over Treasuries, rents have risen along with rates. The location you could have rented in 2021 for $12/square foot is now $20. Thanks to elevated building materials and construction costs, new development is cost prohibitive at $400-500 a square foot (while existing stores transact around $200).

So while owning your stores is expensive, it can protect you from higher costs in the future. This is an industry with 2-3% margins and 2-3% occupancy costs. Small changes in one yields big changes in the other. Kroger and Albertsons have $19 billion of future lease obligations while Ingles has less than $100 million. If rates continue to rise, I know which hand I like better.

HIDDEN ASSETS: Not only does Ingles own its stores (and in most instances, the ground beneath), it owns 101 shopping centers with 9.3 million square leasable feet. They occupy 4.5 million of this, leaving 4.8 million to rent to other tenants. Instead of letting developers capture the value of their traffic, they decided to capture it themselves. Plus, having your choice of neighbors has competitive value. In the past 10 years, they’ve bought 57 parcels of land, acquired 3.1 million square feet and 29 undevelpped sites. This cost $1.5 billion (compared to their $1.2 billion market cap). While all grocers spend to keep their locations attractive, Ingles has been quietly building an empire. Publix is the largest private grocer and has been pursuing a similar strategy.

Ingles isn’t buying land for its own development (their store count hasn’t grown in decades) but as a means to keep other grocers out. Asheville is a land constrained market, surrounded by mountains and the 8,000 acre Biltmore Estate. It lacks a Costco (but does have a Sam’s Club), so locals drive more than an hour to Greenville and Spartanburg, South Carolina, two markets smaller than Asheville.

Ingles 4.8 million square feet of leasable space generated $27 million of rent and $36 million of funds from operations (FFO) last year. These properties are on their books for just $290 million and given prevailing cap rates I estimate their value at $25-30/sh.

REIT COMPARISON: I count nine retail REITs that are at least 50% grocery store anchored. Many of their selling points apply to Ingles as well.

·         The Southeast has attractive population growth and rising incomes.

·         Grocers sell essential goods with low economic sensitivity and ecommerce risk.

·         75% of grocery anchored shopping centers were built before 2000 presenting redevelopment opportunities with high incremental yields.

·         There has been little net new supply in 20 years and long lease terms often renew at much higher rates (known as mark-to-market).

Comparing Ingles real estate holdings to public REITs isn’t an apples-to-apples exercise. For starters, most REITs focus on prime metro markets, rather than secondary markets. Their tenants tend to be national big-box retailers rather than restaurants and salons. 61 of Ingles centers are less than 100,000 square feet and they don’t report occupancy statistics making rent comparisons difficult.

However two contrasts are obvious. The first is that most REITs’ debt load is two to three times that of Ingles (expressed as debt/EBITDA). The second is that they trade at an average of $283 of Enterprise Value per Square Foot compared to Ingles at $102. While Ingles rents per square foot are lower, they’ve been growing much faster.

 I’m not suggesting that Ingles should convert to a REIT. REITs must derive 75% of their income from real estate and distribute 90% of their income to avoid corporate tax. Ingles makes 90% of its income from selling groceries and real estate ownership has competitive advantages. But when a company with grocery-anchored real estate trades at a 65% discount to grocery anchored REITs, all of whom have far inferior balance sheets, my interest is piqued. The smaller market discount seems unjustified. Four of them disclose grocery sales per square foot, and Ingles’ sales are 85% of their average (and very close to PECO and BRX).

BALANCE SHEET: In addition to their real estate spree, Ingles has strategically repositioned its balance sheet by paying down $287 million of debt and building $311m of incremental cash. All of its debt is fixed or swapped and the first maturity isn’t until 2031. It has $12 a share more cash than it did in 2019, could borrow $350 million and still maintain leverage under 3x (it was north of 4x for most of its history). Bankers probably look at their $1.5 billion of unencumbered land and salivate.

Obviously, interest rates are higher than they were, but Kroger’s 2034 issue currently yields 5.2%. Ingles could probably borrow at 6%, remain conservatively levered and use debt and excess cash to buy back more than half of its stock. It’s averaged 19.7% return on equity the past five years yet trades below book. That’s a high cost of capital. I suspect a buyback is likely (although it may be modest relative to capacity) but it shouldn’t be difficult to create value.

OWNERSHIP: Controlled companies are tricky. Given the Ingles family’s 72% voting control, you’re placing a high degree of trust in their abilities. To be fair, Walmart is a controlled company too. Ingles’ board is not required to be independent, they frequently engage in related party transactions (negotiated at arm’s length, of course…) and the Chairman’s compensation has risen substantially over the past four years (although is hardly egregious). They make no effort to engage shareholders (no calls, presentations or management access) and the dividend policy has been stagnant.

But to minority shareholders, actions speak louder than words. They’ve pursued a differentiated real estate strategy, demonstrated balance sheet discipline and compounded capital at impressive rates. While the stock is down 40% from its all-time high, it’s grown book value per share 135% since the pandemic and 311% over the past 10 years.  

Bobby Ingles has a sister, Laura Lynn (the namesake of the store’s private label brand) who has liquidated her B shares. The Asheville Watchdog makes Bobby sound more interested in his cover band (he’s a guitarist) than running the region’s largest public company. That being said, the company repurchased $80 million in shares in 2021 (at prices similar to today’s) and $100 million across 2013 and 2014. They don’t issue stock comp and their headquarters is modest. Maybe being run like a private company isn’t so bad.

M&A: Given the need to scale, supermarket consolidation has been rampant. Obviously, Kroger made a run at Albertsons. Aldi bought Southeastern Grocers in 2023 (a chain of 400 stores and home to the Winn-Dixie brand). They kept the locations they wanted and sold the remainder to C&S Wholesale. Because all three are private, terms were not disclosed. Kroger acquired Harris Teeter in 2014, which had 212 stores in a similar geography. While obviously much has changed since then, their terms would suggest a price between $96-145/sh. I have no particular insight into their strategic plans, but point out that consolidation is only likely to increase and 200 store chains that own their real estate with high geographic density and market share would likely be attractive to an acquirer.

VALUATION: Most grocers trade cheap. A lot of their earnings get plowed back into stores leaving little free cash flow for shareholders. You can buy the category leader, Kroger at just 13 times forward earnings and last summer it traded as low as 10. Compare that to Walmart at 37 times or Costco at 57 times respectively.

And the current outlook isn’t great. Tariffs would be negative for grocery affordability (50-60% of fruits and vegetables are imported from Mexico). Our food supply chain is highly dependent upon migrant workers especially fruit/vegetable picking and meat packing. Wages may rise further and I doubt SNAP benefits will expand anytime soon. But food prices and political popularity are closely intertwined and often self-correct.

I value Ingles on normalized earnings, using its 10-year average operating margin pre-COVID to arrive at $7/sh in earnings and $320 million of EBITDA. As the balance sheet has become cash heavy, you would expect the multiple to expand, not contract. It averaged a 13 P/E from 2010 to 2019 which would yield $93/sh. A 1.3 times book multiple would yield $105/sh. According to JLL, the average grocery anchored real estate trades at $203/sq ft. I reduce this by 15% to account for lower productivity and netting debt and cash would yield $120/sh. Averaging the three yields a price of $106/sh.

CONCLUSION: I chose Ingles Markets to illustrate my process for a few reasons.

• I like special situations. While the suffering from Hurricane Helene is tragic, a previously stable business sold off meaningfully.

• Ingles has capital optionality. The land/cash rich balance sheet gives management numerous levers to create value.

• Ingles has an asymmetric risk reward. It trades close to its lowest valuation ever and materially below its long-term averages. It trades at a discount to private market value and has a long history of attractive returns on invested capital.

• Ingles is undiscovered. Because the company doesn’t engage with shareholders, it has no sell-side coverage.  

Thanks for reading.   

Dan Walker