Grupo Comercial Chedraui (CHEDRAUIB-MX, $4.91) Posts a Strong Earnings Beat for Q4, 2022.

(All figures are expressed in USD unless otherwise stated. Mexican pesos are converted to USD at the fiscal 2022 year end rate of 1 MX peso = $.0514 USD)

In Q4, food inflation continued to provide an impressive tailwind for pure grocers.

Well known retailers, such as Walmart, attributed 100% of Q4 sales improvement to the selling of groceries, while all other categories of consumer retail declined. Walmart generated more than 60% of gross sales in their fiscal quarter from food and sundries. However, non-food categories sold at Walmart, such as electronics and clothing, suppressed very strong profit growth earned from the selling of groceries to the American household.

Walmart also noted that there has been a major trade-down, from high cost food retailers, to lower cost retailers, of which they are a force. Deep discounters, such as privately owned Aldi and Lidl, are also becoming better known in the United States and are pulling market share away from higher cost grocers.

This begs an important question:

“which purveyors of groceries are increasing market share and which companies are losing market share?”

Grupo Chedraui, through its Smart & Final cash and carry grocery label, is sitting squarely in a sweet spot during this inflationary environment and the Q4 results were confirmation of the same.

More than 99% of Q4 revenues were produced from food retailing and US operations accounted for more than 56.3% of total sales. The Smart & Final banner, being a cash and carry discount grocer & food service warehouse, is obtaining the trade-down growth from middle and higher income customers that previously were prepared to pay a premium for services, but that now find themselves foregoing curb-side pickup, concierge shoppers or online delivery in order to save a dollar.

If, as I expect, inflation continues to be very sticky throughout 2023, more middle and high income households should likely trade-down from higher priced stores to discount grocers. That will benefit the Albrecht family who owns Aldi and Trader Joes, but as that firm remains private, a perfect, publicly traded, play in discount grocers does not exist at the present.

Grupo Chedraui is, to my way of thinking, one among far less than a handful of publicly traded food retailers featuring the existing banners, the balance sheet strength and operational discipline required to fully capitalize on the inflationary grocery down-trade in the United States. The longer inflation persists, the greater the runway for this mid-cap.

4th quarter 2022 results easily surpassed the most optimistic expectation for earnings.

There is very limited street coverage of Grupo Chedraui. At the high end, Q4 revenue was anticipated to touch $3.62 billion US, with earnings forecast at $.07 per share. As it turned out, Grupo Chedraui generated $3.6 billion US of revenues, but came in with net earnings of $.112 per share. The difference in estimated revenues from the street vs actual revenues was entirely due to a 6.7% decline in the value of the US dollar vs the Mexican peso during the final fiscal quarter of the year. Had currency remained constant, Grupo Chedraui would have generated the equivalent of $3.74 billion US, easily taking out the highest estimate.

The obliteration of the bottom line forecast, by more than 60%, was due to margin expansion on revenues. For the final fiscal quarter of the year, Chedraui generated a net profit on revenues
of 3%, the highest figure, as a percentage of revenues, in corporate history. EBITDA in Q4 was reported at $305.5 million US, again, a record result.

It takes time for a newly opened store to go from loss (pre-opening expenses), to break-even, and ultimately to match the average profit of an existing store.

In the 4th quarter of 2022, Chedraui opened a total of 18 new stores in Mexico, and also closed on the acquisition of the 36 Arteli mercado chain. A brand new Smart & Final location was opened in the United States, the first new opening of a US store by Chedraui in four years. This 55 store increase in the footprint increased the net store count by 7.4%, in just one fiscal quarter, with the Arteli stores only reporting revenues for the final two weeks of fiscal 2022.

At year end, Grupo Chedraui reported 25.88 million square feet of retail space in their various banners. During fiscal 2022, a total of 30 new stores were opened and 36 acquired, bringing the net count up to 66 overall, 86% of which were opened or acquired in the final fiscal quarter of 2022.

The expansion phase will continue steadily throughout 2023.

At year end 2022, Grupo Chedraui operated owned 780 grocery stores in the United States and Mexico. For 2023, 64 new stores are planned; 60 of the new locations are to be opened in Mexico with 4 new location planned n the United States. In the USA, 3 will be under the Smart & Final banner as well as a new location under the El Super banner.

As to fiscal 2022 results; they demonstrated the benefits of operational discipline and an inflationary tailwind.

Total revenues for 2022 came in at $13.3 billion, an increase of 37.6% over fiscal 2021.
EBITDA was reported at $1.1 billion, up by 53.2% over fiscal 2021.
Net profits were reported at $317.4 million, up by 77.4% over fiscal 2021.

On a consolidated basis, Chedraui’s management has not diverged from the recent guidance.

An average overall EBITDA expansion of about 15 basis points is being targeted for 2023. Mexican retailing operations are guided towards a 15.5% midpoint total revenue growth rate. US stores are forecast to grow revenues by 5.5%. Real estate leasing operations, a minor revenue producer, yet one that carries an extremely high profit margin, is anticipated to grow revenues by about 12%. All in all, should guidance be met in 2023, total revenues are anticipated to be $14.6 billion US, an increase of 9.8%.

Corporate guidance, now based upon actual fiscal year end revenue, presently exceeds the highest analyst assumption. Until today, the average forward revenue estimate was $13.7 billion of revenues for 2023 with an outlier forecasting 2023 revenues of $14.45 billion.

Providing that the EBITDA forecast is met, this suggests that retail EBITDA of $1.2 billion is anticipated as well as potential real estate rental EBITDA of up to $45 million, for a consolidated total in the range of $1.25 billion for 2023. Upside or downside to this forecast now must also factor into account forex; the Mexican peso appreciated against the US dollar in 2022 and thus far in 2023 has continued to outperform. With a renewed emphasis on organic expansion in Mexico, it would seem that the Chedraui family intends to increase Mexican revenues and narrow the revenue gap between US and Mexican operations.

There aren’t enough publicly listed pure play food retailers in the US to be talked up by leading investment houses, so analysts DON’T talk them up.

In 2023, the typical US household may spend about 13% of their income on food and household spending represents about 70% of US GDP. Yet, the combined overall market capitalization of the entire grocery sector is less than $1 trillion US, and that’s being generous. The market cap of Walmart is less than $400 billion, and about $240 billion of that cap is tied to grocery sales. Costco, a company with a market cap of $220 billion, generates less than 35% of its total revenue from grocery and therefore doesn’t benefit enough from selling food to offset margin declines on their non-food offerings. Structurally permanent food loss leaders at Costco make margin accretion a challenge at best, a broken thesis at worst, so Costco is a poor play on food inflation.

Kroger is the largest pure play in the United States at present, but with a market cap of just $32 billion and lacking a hard discount banner, just isn’t captivating to those seeking to benefit from consumer inflation trade-downs. Albertsons is to be acquired by Kroger, and should that proceed, there could be merit to revisiting the combination at that time.

Koninklijke Ahold Delhaize N.V sports an enterprise value of $48 billion and is notable for a roaring business in the United States. Delhaize sells for a metric of just 7.7X trailing 2022 EV/EBITDA but institutional interest is held in check due to the lackluster European operations and a corporate emphasis on using profits from US operations to invest more heavily in Europe, all the while undergrowing the US store count. The holdback for me on Delhaize is this inexplicable, euro-centric biased corporate policy of starving a faster growing US division of beneficial expansion capital while throwing it away on no-growth European operations.

BJ’s Wholesale Club is a very fast growing US only membership warehouse with a heavy emphasis on food but with a market cap of just $10 billion, it barely qualifies as a large cap; no institution interested in building up a holding in BJ’s wants to tout the retailer, for fear of moving the market to the point where the shares get away from them.

No, there just isn’t a well known, easily investible, pure play name out there in the large cap space. If one wants to own the sector and perhaps profit on the grocery trade-down that is underway by higher and middle income Americans, there is almost nothing to choose from. Decades of low inflation sapped the margins of grocers and broke the resolve of investors who could not determine how the sector could outperform; typically no financial reward is to be earned by investing in any business with growth matching barely GDP and featuring low margins.

As a result, the category has been largely overlooked by investors.

Until consumer and producer price inflation came roaring back, starting in late 2020, this was the prudent call. Even today, the aggregate market cap of grocers is far too low to accommodate a massive influx of capital without resulting in a price shock on the upside. Conversely, if institutions needed to exit a position, an absolute lack of liquidity would almost certainly result in a negative price shock. Institutions desire liquidity and the market cap of the entire publicly traded grocery sub-sector of retail is too low to attract hot money. So, any money invested in the space isn’t the hot money, but the careful money. Careful money typically doesn’t advertise their intent.

Investors ignoring grocers fall into the camp that inflation still isn’t really a thing, that the Federal Reserve Board has this fully under control, that governments will just reign in spending and that households can choose to eat less, that they will grow their own food, press their own vegetable oils and pressure can their own vegetables. All this is indeed possible, but is it probable? I do see daily what the federal reserve bankers are attempting to do and report on it dutifully, but their policies are reactive and they are operating at odds with government actions, leading to less success than was projected, certainly not in prior timeframes that were forecast.

In the meantime, the typical American household continues to reduce spending on value added items and services while trading down in their grocery purchases.

Substitution represents an entirely rational decision that falls short of wholesale lifestyle changes. Sometimes, a temporary substitution turns into a long term change of shopping habit. As it turns out, I have found that a well roasted Robusta coffee bean actually suits my taste better than Arabica, and does so at roughly 1/2 the price. For decades, marketers had sold me on the qualitative benefits of Arabica beans, via persistent and savvy marketing, only to have their advertising campaigns be completely upended by inflation. The hundreds, perhaps thousands, of dollars expended to market pricey Arabica coffees to me, over my lifetime, is now a sunk cost for coffee companies, and they need to start over.

There is some potential for permanent dislocation of the household food dollar, should inflation be persistent. I wonder how many investors have thoughtfully cogitated on the implications.

This isn’t an “any grocery store play is a good play” type of market.

Rather, to quote Logan Roy, the mercurial patriarch of the hit TV series, Succession: “This life is not for everyone. It is a number on a piece of paper. It is a fight for a knife in the mud“.

Food retailing is far from glorious. The business is a cutthroat affair, one where deep discount grocers clearly have the upper hand and are expanding to seize the day. Should food discounters possess the balance sheet strength to open more stores than competitors and wrestle increasing market share away from “woke”, experiential, grocers specializing in pricey Kombucha, Liberica coffee beans and artisanal nut butters, that is their runway.

How long this inflationary pressure persists is the question. I have my views and recognize that my models significantly differ from prevailing investor sentiment, but then, they typically always have.

Almost no American investor or Wall Street investment house is aware of Grupo Chedraui as a publicly traded company.

An increasing number of shoppers at Smart & Final, no doubt, do not give a second thought to who or whom owns the stores. Yet, Chedraui, in the coming several years, will more likely than not surpass 1000 grocery stores, under several banners, on the continent. Management has demonstrated an ability to make immediately profitable acquisitions and runs their operation with fiscal discipline unmatched among publicly traded peers.

Costco sells for a current enterprise value 46X that of Grupo Chedraui and total sales for 2023 at Costco are an estimated 16.8X higher.

Yet, COST only sold 5X more groceries than Chedraui in 2022. About 16% of forecast Costco revenue is anticipated to be generated from zero margin gasoline sales. The remaining majority of Costco revenue comes from such low/no profit margin categories, that Costco is likely to only generate 7.5X greater EBITDA in 2023. Chedraui is forecast to operate about 22% of the net retail selling space as Costco at the end of 2023. By the end of 2023, Costco, a much slower growing retailer, will only sell about 4.5X the volume of groceries vs Chedraui.

Most important to any investment thesis, Grupo Chedraui, despite the revenue disparity, is likely to earn as much as 50% greater net profit per dollar of sales than will Costco for 2023. One company has an enterprise value of about $230 billion, and one company has an enterprise value of just $5 billion.

To frame the value differential in another way: were I were to hold just 8 shares of Grupo Chedraui, at an investment outlay of less than $40 US, I would be earning the same proportionate EBITDA as an investor who holds 1 share of Costco (and they had to stump up almost $500 for that EBITDA). When I hold 17 shares of Chedraui (investment cost of $85), that amount generates the same proportionate revenue as those holding 1 share of Costco. Finally, it only requires an investment of 14 shares of Chedraui ($70) to generate the same forecast profit for 2023 as it does for a holder of 1 share of Costco.

The Grupo Chedraui valuation of 4.3x trailing EBITDA and possibly less than 3.8X forward EBITDA might seem fair for a “no-growth” company.

That discount to growth stocks was what investors decided grocers were worth during the low-inflation environment of the past two decades. The markets will ultimately decide upon an appropriate valuation should inflation persist in the coming years; operating assumptions that grocers don’t offer revenue or profit growth have clearly changed. Inflation has important implications for any investment allocation model.

The Chedraui family has expressed a willingness to grow via acquisition, they stated as much in their Q4 report.

There are dozens of larger and smaller regional grocery chains, predominantly privately held, in the USA. Smaller regional grocers might now be viewing the current market as an opportunity to sell for a fair price and Chedraui now generates enough free cash flow to target transactions up to $500 million without the need for expensive financing. Outside of Mexico, the preferred acquisition locale lies in the US southwest states (California, Nevada, Arizona, New Mexico and Texas) where the in-house logistics expertise of Grupo Chedraui could positively impact the sourcing of fresh produce & fast growth Mexican brand names.

What has been confirmed, over multiple years, is that Grupo Chedraui is about the furthest thing from a no-growth company possible.

In order to truly gain the attention of US investors, I feel that annual sales in excess of $20 billion will be required, as will a US listing on a major exchange. A few more inexpensive bolt-on regional buys from Chedraui could tighten up the timeframe to that $20 billion revenue pathway and would bring the company closer to that $10 billion market cap. In the interim, organic expansion of the store count will continue at a record pace.

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