(All prices converted from MX peso to US Dollars at the rate of 20.0925 pesos per US dollar).
Grupo Chedraui reported Q3 revenues of $3.22 billion US. Gross operating profits rose year over year to 23.4%, up from 22.6%. Net operating margins were 5.3% ($171.8 million) in the quarter, up from the 4.8% figure issued in the prior year’s quarter. EBITDA margins were 8.3% in Q3, an increase over the 7.5% margin reported year-over-year.
Finally, net profit margins of 2.3% represented a significant improvement over the 1.7% figure reported in the 2021 Q3 quarter.
On a USD basis, Q3 EBITDA came in at $268.1 million as compared to EBITDA of $265.7 million in Q2. Net profits were marginally lower, coming in at $73 million, or .076 US per share, vs the $75 million profit or $.078 US per share earned in Q2.
The acquisition and consolidation of the Smart & Final cash and carry warehouse chain has shifted the geographic mix to a clearly US-centric business model.
American operations accounted for 60.3% of total revenues. This in no way is meant to diminish the relatively superior performance reported by the Mexican division. Mexican sales growth was +15.8% year over year and generated an overall EBITDA margin of 8.6%, up not only on the YOY, but also an improvement over the 8% rate generated in the second quarter.
Mexican operations generated a better EBITDA margin performance than the overall US operations. US retail sales earned an overall EBITDA margin of 7.7% in Q3 vs an 8.2% rate indicated in the second quarter of 2022. Among the US banners, El Super margins were relatively stable at 8.7%, Fiesta Mart margins rose slightly to 6.5% and Smart & Final margins declined to 7.7%. down from the 8.4% rate earned in Q2.
Management of Grupo Chedraui believes the margin decline in US operations to be very temporary.
Certain one-time costs on the Smart & Final division, that I assumed were buried in the books, were finally taken on the expense ledger. Every acquisition, even the great ones, typically has something under the rug and it is just prudent business to sweep it out the door, once identified.
An overall EBITDA margin of 7.7% US at Smart & Final seems to be an anomaly for my account, considering that I typically opine on investments that routinely generate 30% plus EBITDA rates on sales. However, I appraise corporations not just on an absolute basis, but on a relative starting point against industry peers.
To place the return on the cash and carry business of Smart & Final into perspective, let’s consider how a 7.7% EBITDA margin compares to the industry darling, Costco. Costco generated a net operating margin of 3.5% in fiscal 2022 and reported an EBITDA margin of just 4.3% for the most recent fiscal year ended August 28th, 2022.
Chedraui closed 2 Smart & Final locations in Q3.
Having spent the first year going over the stores in detail and taking into account the very low price paid for the entire chain, it would be highly unlikely to determine that at least a few locations wouldn’t meet the internal hurdle rates set out by Chedraui. After about a full year’s internal data was reviewed, it turns out that several stores did not meet the internal profit hurdles. Lease termination expenses are the result.
Grupo Chedraui intends to offset these closures by opening up 2 new Smart & Final warehouses in Q4; one was previously identified in a prior blog posting. Provided that no more closures take place, 2022 could end the year with the same number of locations overall. Absolute growth of the total store count, in that division, still remains at least one quarter off.
Closures of underperforming stores are not a novelty in the grocery or warehouse business. Provided that a retailer replaces shuttered stores with new openings on a timely basis, that’s retail. Once again, by way of example, Costco, whose investors are schooled to believe represents a business model impervious to competition: Costco shuttered 3 stores in 2022.
Mexican store openings in Q4 could exceed the total reported store openings for the first 9 months of 2022.
A total of 12 new retail locations were opened in Mexico during the first 9 months of 2022. In Q4, as many as 19 new locations are projected by management to open.
Annual EBITDA remains well on track to exceed $1 billion US for 2022.
The real estate ownership and leasing division continues to stand out, driven by additional square footage completions, higher occupancy levels in their malls as well as annual rental fee increases. A more modest margin expansion in the Mexican retail stores, in the area of 10 basis points to 15 basis points, remains the goal for Q4.
Depending upon the exchange rate between the US dollar and the Mexican peso, and assuming that management’s margin forecast holds up for the balance of 2022, EBITDA could be in the range of $1.05 billion US. Net liabilities have declined steadily throughout the year with cash flow exceeding capex in each fiscal quarter.
YOY easy comparisons, based upon the first year’s ownership of Smart & Final are now about over.
Chedraui shares have enjoyed a strong run for much of 2022. Given the fact that about a billion US of market cap has probably been added to the Chedraui share price, likely largely attributable to market awareness of the Smart & Final accretion, a period of consolidation will not be a surprise, prior to analysts taking a forward look into 2023.
Next year, Grupo Chedraui will no longer have the benefit of the accretive acquisition tailwind providing significant revenue and profit growth comps. 2023 growth rates will be modeled off the 2022 fiscal year results and will serve to reduce comparable sales growth to a far more measured pace, one based upon retail inflation plus market share growth in competing regions.
Chedraui has proven itself entirely capable of taking on Walmart in Mexico and is leading the Mexican grocery group in terms of market share growth while also growing operating and net margins in that country.
The key to future success, in 2023 and beyond, will be based upon faster rollout of the Mexican and US store banners.
Further acquisitions, such as a purchase of some cast-offs in the Albertsons-Kroger combination, are probably out of the question due to the prices sought and because grocers are now considered to be a “hot” investment; bargains are no longer available. Growth via new store openings is the only logical path, because expenses cannot be wrung out of an inflationary economy. The balance sheet of Chedraui has been improving for all of 2022; I would anticipate that on a go-forward basis, more cash flow will be diverted towards store openings rather than to debt paydowns.
US retail market success will be critical in order for Chedraui to ascend to smallish, large cap status. The store formats are capable of taking on any grocer or big box warehouse with success; they have already done so. EBITDA margins are best-in-class and balance sheet fiscal management are such that an acceleration of organic sales growth in 2023 can be readily accomplished, should management choose. Now, it is up to the Chedraui executive to commence their program to achieve that growth potential.
2022 was the discovery year. 2023 will be the “show-me” year.