Thursday, September 07, 2006

Ahold- Breaking Up is Hard to Do

A funny thing happened last night...Ahold (AHO) the troubled European food retailer reported very positive and encouraging improvement in its profitability. We certainly haven’t seen that happen lately.

Ahold, though not very well known to many in North American investors, has the great bulk of its operations in the U.S. with its ownership of Stop & Shop, Giant-Landover, Tops Friendly Markets, Giant-Carlisle, Martins, and the internet grocer, Peapod. It also owns U.S. Foodservice which services restaurants, hospitals and universities.

Operating profitability in the second quarter at Stop & Shop/ Giant-Landover was up 20% YOY with operating margins of 5.8% versus last year's 4.9%.

At Tops/Giant-Carlisle, operating margin came in at 4.3% versus 3.7% and grew 9.3% YOY.

U.S. Food Service operating profits were up 84% with op margins of 1.8% versus 1%.

In Europe, its Albert Heijn division had operating margins of 6.2% versus 4.4%.

It appears that cash flow from operations has improved significantly, and the balance sheet has improved as well with net debt down by 531 million euros to 5.2 billion.

Despite revenues that seemed relatively weak and a competitive landscape that is hardly improving, Ahold appears to have enjoyed a tremendous shift in its operating profitability.

Some large hedge funds smell blood and have been demanding a break-up, selling off of the U.S. assets. Two funds, Paulson and Centaurus announced Aug 14th that they had accumulated a 6.4% position in Ahold and were attempting to rally some other large shareholders to demand the break-up.

Management may have bought itself some time with the improved results. The U.S. divisions have been valued by some analysts on the basis of the Albertson takeover, but it is hard to argue that the assets are similar. The age profile of many of the Ahold stores suggests that more than just maintenance capex is required. Management has been dedicated to survival and debt reduction rather than refurbishment. Solid progress has been made in debt reduction since net debt back in 2001 was 12 billion euros! Their efforts in operations have paid off for the first time in years.

Much work remains to be accomplished. Contrast AHO's ROA of around 1% to Tesco's exalted 7%. Lesser food retailers have ROA’s of 2-4%. Albertson’s was 2.5%. Ahold's Central European operations are losing money versus Tesco's success. From a valuation standpoint, the EV/EBITDA is around 10 times TTM, not that terribly cheap, given the still relatively low profitability.

A speculation on a break-up is not a particularly inviting investment in my view. Management has refused to meet with the hedge funds as of yet and it appears that these results will kindle more hope for recovery rather than restructuring.

Disclaimer: Neither I, nor my family have a current position in Ahold. However, certain clients do own a current position in Ahold.


At 1:05 PM, Blogger Leadsteer said...

Nice article. I, too, would pass on AHO. The ROA is low (~1%) and the PE is high (~20x).


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