Now that you know the OMM family has been eating more healthily lately, I’ve been thinking more about the profitability of various grocery chains. How much profit do the larger chains generate and how efficiently do they do so? I’ve heard in the past that groceries are a low margin business, and that kind of makes sense. People don’t want to pay a premium for the necessities of life, so grocery stores have to make their money primarily on volume.
This time in my life coincides with another tool for investment analysis that I learned recently – return on equity. I have come to learn that excellent, long lasting businesses tend to have bigger than average, sustainable returns on non-leveraged equity. It has been said that the performance of a stock, held over the long term, will eventually revert to around the return on equity figure. Although I have yet to do a lot of research to see what kind of data backs up this claim, I realize that this intuitively makes sense, when you break down the definition of ROE. Let’s look at that.
Return on equity is a financial ratio that determines how efficiently a business turns its assets into profits. In fact, the general equation is pretty simple:
ROE = Net Income / Shareholder’s Equity
This can be measured over a twelve month period, over a multi-year period, etc. That’s the basics of it. What I learned though is, there is a better way to calculate this same number that isolates the different variables that comprise the equation. This is thanks to Joshua Kennon’s writings over at about.com.
It’s called the duPont Return on Equity. It produces the same number as the calculation above, but uses more variable to get there. Namely:
duPont ROE = (Net Profit Margin) * (Asset Turnover) * (Equity Multiplier)
Let’s quickly define these terms:
Net Profit Margin = Net Income / Revenue
Asset Turnover = Revenue / Assets
Equity Multiplier = Assets / Shareholder’s Equity
Net Profit Margin is how much money the company makes, after expenses, relative to gross sales. Asset Turnover just relates the gross sales to assets, telling us how quickly the company is turning assets into sales, and the Equity Multiplier looks at how much of the Shareholder’s equity (assets – liabilities) is made up of assets. Notice that is also tells us how much debt an enterprise uses in its capital structure, in relative terms.
Let’s look at what these numbers are for a handful of the largest grocery chains in the United States. We’ll examine: Delhaize Group SA (DEG), Kroger (KR), Walmart (WMT), and Whole Foods Market (WFM). There are other big grocery companies too, including some that are not publicly traded, but these are the big guys in the U.S. market right now that are.
Looking at each company’s most recent 10-K, all of the numbers needed to calculate the financial ratios mentioned above are there on the statement of cash flows and the balance sheet. Here’s the data:
As you can see, each grocer has its own unique characteristics when it comes to business, and that is reflected in the numbers. Look at Walmart for example. It is a behemoth. There were over $480 billion in sales in 2015! It makes even an established national grocer like Kroger look small in comparison.
What about the profits though? We can see that Walmart still has a net profit margin that is higher than the other two traditional grocers, Kroger and Delhaize Group. Why? I don’t know exactly, but it would make logical sense to me that this is the case because 1) Walmart is so big it has more bargaining power when purchasing goods from suppliers, and 2) Walmart has a more diverse product mix than traditional grocers, some of which provide higher margins. For example, Walmart’s toy and electronic sections probably provide higher margins than their grocery section.
Interestingly, Whole Foods Market has the highest profit margin out of the group. This is likely due to its emphasis on quality organic foods, which customers are willing to pay higher prices for compared to traditional grocers.
Looking at the equity multiplier is what I find most interesting. Out of the four firms, Kroger is the most highly leveraged in its capital structure, with an equity multiplier last year of almost 5.0. This leads to a higher return on equity – 30%, which is quite high. If we break out the equity multiplier in the equation however, the non-leveraged ROE for Kroger is only 6%, which is not too impressive. Although this is only a snapshot based on 2015, this leads me to believe that Kroger’s business model does not lend itself to as much free cash flow if debt was not part of the equation.
Check out the ROE and non-leveraged ROE based on the above data:
Delhaize Group is definitely the least efficient at generating profits of the four firms, both based on absolute ROE and non-leveraged ROE. It also has the lowest profit margin.
What I find interesting is that, on a non-leveraged basis, Whole Food Market has the highest return on equity, at almost 10%. That doesn’t seem too shabby! Furthermore, Whole Food’s total debt burden is only at $65,000,000. When compared to net income, this seems to be pretty good. If management wanted, they could spend not even two months’ worth of the company’s profits and wipe out all of the debt. However, since Whole Foods is a relatively young company and is still rolling out across the country (and world), I expect this debt, in absolute terms, will only increase as new locations are being built.
Although the return on equity figure is just one metric that can give us some insight into the financial health of a business, it is an important one. It’s interesting to see that large differences exist between even just a few large firms that exist within the same space.
P.S. One interesting side note – I looked up the data for Publix, the huge grocery chain in the southeast. Although the corporation is not publicly traded (the reason I did not include it here) there is public financial data out there on the internet because the firm does have shares floating around on the over the counter market. The company’s management grants shares to many of their employees.
I found in interesting that Publix’s ROE figure based on 2015 data is 16%, and it’s non-leveraged ROE is a solid 12% – something to take notice of. Publix has double the revenue of Whole Foods, but almost double the net income, leading to a profit margin of 6%. In the grocery business, that definitely seems impressive.
I have memories of being a kid growing up in the Orlando area. There was a popular Winn-Dixie grocery store that operated in one part of town. One year, Publix opened a big new store right across the street. My family immediately started shopping there because of the big new aisles and solid prices. Within a year or two the Winn-Dixie was clearly struggling. Although I haven’t shopped there in many years, I’ve got a feeling that Publix is a supermarket powerhouse, as my own anecdotal experience and a first glance at the numbers leads me toward that conclusion.