May 5, 2022

The market remains very challenging for high-growth stocks. While I have a list of innovative companies I’m excited to recommend (at some point), for now we’ll continue to diversify our portfolio with more value-oriented names.

This month’s new addition is a little-known supermarket chain I’ve been following for some time. The pitch is very straightforward – rising prices and an insulated business model should help the company post impressive growth in 2022 and 2023. Not to mention we have upside if/as the name spreads among investors that are increasingly looking for just this kind of stock.

Last but not least, the chart looks fantastic.

Company Overview

The Big Idea
In the mid-1950s Robert Ingle, part of a third-generation grocery family, was working in a store his grandfather, Elmer, had started. Robert had been kicking around the grocery store since he was five. Over the years he developed ideas of how to make a bigger store model work.

In 1956, after his grandfather passed, the store closed and Robert went off to college in Miami, Florida. By 1961 he was back in the Carolinas, working for the Colonial Stores chain. He still had bigger plans.

He soon secured the necessary financing to open his first Ingles store in Asheville. It was 1963.

Robert’s vision was to build a chain of grocery stores in the rural areas that were overlooked by the bigger grocery chains. He wanted to own the real estate under the stores as well.

While there were certainly some bumps along the way, the big-picture strategy worked. Over the years, Ingles Market expanded into many small communities in South Carolina, Georgia, Tennessee, Alabama and Virginia.

In 1982 Ingle purchased Milkco, a milk processing facility. The idea was that Milkco could supply both the growing footprint of Ingles Markets, and other retailers, wholesalers and food service distributors as well.

Milkco is still operating. Annual production has grown from 5 million gallons in 1982 to over 60 million gallons today.

In 1987 Robert Ingle took his company public under the ticker IMKTA. He passed away at age 77 in 2011, at which point his son, Robert P. Ingles II, stepped in.

While Ingles Markets has grown significantly over the years, it is still a relatively small and unknown company. It’s extremely profitable and pays a modest dividend.

Like other grocery stores, including Kroger (KR), Sprout Farmers Market (SFM) and Grocery Outlet (GO), the stock has been moving higher as investors buy into the space to gain leverage to rising prices.

I don’t expect we’ll own shares of this stock forever. But in the current environment I like the relative simplicity of this business, the strong fundamentals and the tailwinds that should power the stock higher. I think we can do very well owning shares over the next six to 18 months, so we’ll jump in now.

New Recommendation and Updates

The Company

A quick note before we jump in. With Q2 earnings just being released this morning (they were good) I am starting IMKTA at BUY A HALF. Since earnings updates are notoriously impossible to predict we will monitor the stock’s reaction this morning and go from there.

Ingles Markets (IMKTA) is an Asheville, N.C.-based chain of 198 supermarkets that span North Carolina (75 stores), Georgia (65 stores), South Carolina (35 stores), Tennessee (21 stores), Virginia (1 store) and Alabama (1 store). Almost all stores operate under the name Ingles Markets, though nine supermarkets operate under the Sav-Mor store concept (get it, “save more”?).

As you’d expect, Ingles supermarkets carry national brands across grocery, meat, dairy, produce, frozen foods and other perishable items. The markets also carry Ingles’ private label brand, Laura Lynn, as well as locally sourced and organic foods.

As of the end of 2021 there were 111 Ingles Markets that have in-store pharmacies and 107 that have on-premises fuel centers. The chain offers online ordering for pickup at 46 locations, with more to be added every month.

Like most grocery stores, Ingles is focused on customer service, convenience, selection, modern store layout and price, all of which are intended to drive customer loyalty and help grow the customer base.

It seems to be working. Over the last five years, sales per store has climbed every year, from $19,133 in 2017 to $23,926 in 2021. Sales per square foot has also climbed every year, from $494 in 2017 to $609 in 2021.

Ingles Markets – Not Hard to Understand
Ingles Markets is not a complicated business, but there are a few moving parts investors should be aware of.

Company-Owned Real Estate
Ingles owns 163 of its supermarkets. Some of these are free-standing stores while others act as an anchor tenant in a shopping center the company owns. Ingles collects rent from other tenants in these shopping centers. In total the company owns 8.1 million square feet of leasable space, roughly half of which it occupies itself. The company also owns 23 undeveloped building sites that are suitable for expansion.

Milkco, Inc.
Ingles Markets owns and operates Milkco, a milk processing and packaging plant which it bought in 1982. This gives the company more control over dairy supplies. In addition to supplying nearly 75% of milk products (including organic milk) for Ingles, Milkco also provides dairy, citrus, tea, ice cream mix and bottled water to food service distributors, grocery warehouses, and independent specialty retailers in 16 states. Annual production has grown from 5 million gallons in 1982 to over 60 million gallons today.

Strategically Located Distribution Center
Ingles self-distributes roughly 60% of the goods it sells from a distribution center on the outskirts of Asheville, North Carolina (same locations as headquarters). The distribution center is strategically located near I-40 (and close to I-26) and is within 280 miles of nearly all stores. It houses grocery, perishable, frozen, ice manufacturing equipment and more. There are even banana ripening areas. Along with Ingles fleet of 170 tractors and 625 trailers, the distribution center and a backhaul program help the company achieve a higher level of self-sufficiency and control over its supply chain.

Laura Lynn Private Label Brand
Ingles sells a variety of brand-name products as well as its own Laura Lynn brand products. Ingles’ private label products are named after Mr. Ingle’s daughter, Laura Lynn Ingle.

Growth Initiatives
Price Increases/Inflation: Recent data (supermarket ticket inflation +8% since mid-February) implies food at home inflation is well underway and likely for the balance of 2022, if not longer. Grocery stores are typically slow to increase prices and that’s been the case lately, though the trend is reversing. In short, all signs point toward price inflation at grocery stores, including Ingles Markets. This should drive earnings higher and, potentially, multiple expansion on grocery store stocks.

Store Renovation & Expansion: Ingles Markets has a store modernization strategy in place to renovate and modernize the appearance and layout of existing stores while also adding new stores. All updated stores include both pharmacies and gas stations. New store builds (that aren’t replacing existing stores) have been hampered by the pandemic (five new in 2018 but only two new in 2021), but management should be able to move forward more rapidly in the quarters ahead now that the effects of the pandemic are easing.

Expand and Emphasize Higher-Margin Products: Newer store layouts emphasize higher-growth, higher-margin products, including local, organic, frozen, deli, bakery and home meal replacement items (rotisserie chicken and pork, international foods, sandwiches, sushi, cut fruit and veggies, etc.).

Expand Private Label Offerings: Laura Lynn private label products tend to carry higher margins than branded products and can help increase customer loyalty. Ingles currently offers private label products like milk, bread, organic products, drinks and canned goods, and is working to expand into more categories.

Ingles Advantage Card: Ingles continues to improve how the company uses data gained from its Ingles Advantage Card, a customer loyalty card that extends special offers and other loyalty programs. The card tracks customer shopping patterns and drives product ordering and promotional activity.

Increase the Dividend: Ingles has been paying an annual dividend of $0.66 for years. It could choose to increase that or issue a special dividend.

The Business Model
Ingles Markets is a supermarket chain that generates most of its revenue from grocery (35% in 2021), perishable foods (27%), and non-food items (23%). Gas made up 12% of revenue in 2021 while dairy operations and shopping center rentals contributed 3%. Advertising is done over radio, TV, direct mail, newspapers, digital and social media.

Product distribution is handled by a mix of company-owned warehouse and distribution facilities (60%) and supplemented by local distributors and manufacturers (40%), which mostly supply gas, beverages, bread and snack foods. Ingles has 179 tractors and 777 trailers to aid in distribution.

The Bottom Line
Ingles Market grew revenue by 2% to 5% annually from 2017 through 2019. Revenue growth jumped to 10% in 2020 then grew another 8%, to $4.99 billion in 2021. Growth came across the board but was especially strong in gas (+27%) and the dairy and rental income parts of the business (+21%), which made up a combined 15% of total revenue. Grocery was up 4%, non-foods was up 6% and perishable was up 7%. Earnings per share in 2021 surged to 12.73, up 44%.

In both Q1 and Q2 2022 (which was just reported this morning) revenue growth has remained very strong, rising 17% (to $1.39 billion) and 16% (to $1.38 billion), respectively. EPS in Q1 and Q2 has been up 31% (to $3.48) and 40% (to $3.61), respectively. These results mean that at the halfway point in 2022 revenue is up 16.6% to $2.77 billion and EPS is up 35% to $7.10. It’s hard to find any issues with those numbers.

We don’t yet have the Q2 10Q so I can’t analyze revenue growth by category in Q2 for today. But looking at the Q1 10Q we already saw the beginning impact of rising prices, with all categories up. In Q1 grocery was +10%, non-foods +9%, perishable +13%, gas +73% and dairy and rentals +17%.

In Q1 Ingles Markets paid a quarterly dividend of $0.165, equal to an annual yield of 0.7%. Expect the same amount in the upcoming payment. Total debt at the end of March 2022 was $578.5 million, down from $647.8 million a year ago. The company has a $150 million line of credit that it has not drawn against at all.

Risk
Founder’s Son Has Significant Ownership and Voting Power: Robert P. Ingle II, the company Chairman, owns roughly 71% of combined voting power and 23% of the total number of shares outstanding.

Lack of Analyst Coverage: None of the big investment banks have analysts following Ingles Markets. This can be both a pro (room for improvement) or a con (nobody cares), depending on your perspective.

Investor Relations Has Room for Improvement: Ingles Markets hasn’t held conference calls for years and, generally speaking, doesn’t do a lot of investor outreach. While the corporate website hosts some information, the average investor is likely to want more. Again, this could be an opportunity.

Grocery Inflation May Prove to Be Limited: While the general consensus is that grocery stores are primed to raise prices and reap the rewards into 2023, there are no guarantees.

Pandemic Growth Comparisons May Be Tough to Top: During the pandemic consumer spending at grocery stores surged (not a lot of dining out). That trend has been easing, making quarterly growth comparisons tough, not just for Ingles but for other grocery stores as well. That said, Ingles has continued to grow on a quarterly basis through 2021 while many other grocery chains have not.

Competition
Ingles Markets competes with a wide variety of other stores, depending on the precise location and size of the community of each store. In SEC filings Ingles lists its primary competitors as Aldi, Bi-Lo, Earth Fare, Food City, Food Lion, The Fresh Market, Harris Teeter, The Kroger Co. (KR), Lidl, Publix Super Markets, Sprouts Farmers Market (SFM), Target Corporation (TGT), Whole Foods Market (AMZN), and Walmart Stores (WMT).

The Stock
Trading Volume: Average trading volume for IMKTA is around 115,000 shares daily ($11 million worth).

Historical Price: IMKTA has been public for years. In 2019 shares picked up some momentum and traded up near 49 but then fell by around 35% when the pandemic struck. They recovered some and traded in the 35 to 45 zone through the end of 2020, then broke out to new highs above 50 following a strong earnings report in February 2021. IMKTA reached 60 in early March, then chugged sideways through October. Momentum picked up again last fall, and by December 15 IMKTA was at 93. A 20% drawdown followed but buyers began to step in in late January. The stock has made a series of higher highs and higher lows over the last three months and is currently 6% off the intra-day high of 102 struck on April 20.

Valuation: IMKTA trades with a 2021 P/E ratio of 7.5. In comparison, SFM has a P/E of 14.8, GO has a P/E of 37, WMT has a P/E of 23.6 and KR has a P/E of 37. The group average of 28 implies IMKTA has significant upside before its valued even close to the peer group average.

Buy Range: Expect to buy between 90 and 100 in the near term (recent high is 102, 50-day moving average is at 91.4). Given that earnings just came out this morning IMKTA may move more than usual today, so we will start with a half position. BUY A HALF

The Next Event: Q2 earnings was just released this morning. Expect the Q2 10Q to be filed any minute, and a Q2 dividend payment date to be announced relatively soon.

Updates on Current Recommendations

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.

Glossary
Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying t Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

Disclosure: Tyler Laundon owns shares in one or more of the stocks mentioned. He will only buy shares after he has shared his recommendation with Cabot Small-Cap Confidential members and will follow his rating guidelines.

The next Cabot Small-Cap Confidential issue is scheduled for June 2, 2022.