There are several things to like about NAFC. First, its free cash flow. The company has generated on average $60 million in free cash flow per year for the last eleven years. This compares to a current market cap of $343 million, representing a yield of 17.5%. Over the same period, revenues increased from an average of $3.9 billion for the first half of the decade to close to $5 billion in the latter half. The company has also made great efforts to repaying its historically high debt load. Debt has decreased from more than 160% of equity around the turn of the century to around 70% of equity recently. Though this is still high by my standards (especially for a business with thin margins, which is common among wholesalers), I am heartened to see debt moving in the right direction.
In recent years, the company has spent $49 million repurchasing stock, reducing the share count by approximately 10%. Additionally, the company has consistently paid a dividend since late 1987, and the current yield is a respectable 2.57%.
Perhaps the most interesting thing is that the company, while consistently profitable (and with positive free cash flow), trades at a discount to book value. As mentioned, the company’s market cap is $343 million, which compares favourably to its book value of $405 million. But wait, there’s more! The company uses LIFO inventory accounting, which in an inflationary environment is less accurate than FIFO. The difference between LIFO and FIFO is accounted for in the “LIFO Reserve” which the company reports in its most recent quarter as such (emphasis added):
Inventories are stated at the lower of cost or market. Approximately 84% of our inventories were valued on the last‑in, first‑out (LIFO) method at December 31, 2011 as compared to approximately 88% at January 1, 2011. During fiscal 2011, we recorded a LIFO charge of $14.2 million compared to a LIFO charge of $0.1 million in fiscal 2010 and a LIFO credit of $3.0 million in fiscal 2009. The remaining inventories are valued on the first‑in, first‑out (FIFO) method. If the FIFO method of accounting for inventories had been applied to all inventories, inventories would have been higher by $87.3 million and $73.1 million at December 31, 2011 and January 1, 2011, respectively.Thus, to get an accurate picture of the value of the company’s inventory today, we would add back the LIFO reserve of $87.3 million, which would increase equity by the same amount. The result would be a discount to book value not of 15% (as would first appear to be the case) but rather 30%.
Now, if the company was in a different line of business or was frequently unprofitable, or if the days of inventory was consistently growing (and thus a cause for concern about the quality of the inventory), I would be inclined to ignore this LIFO reserve. But the company’s business is groceries and other fast turning items, and I see nothing of concern about the company’s inventory relative to revenues, so I am quite excited about this LIFO reserve.
One other thing that I like is that insiders own 1.41 million shares, which equals 11.5% of shares outstanding. This is a healthy amount and there is no issue of supervoting shares or anything that I can see that would cause me to be concerned about corporate governance. It appears that insiders’ interests are aligned well with outsiders.
There are a few causes for concern. First, the Military segment operates in a manner whereby the customer (a particular military commissary or exchange) places an order to NAFC, which then bills the manufacturer of the product. The manufacturer then turns around and bills the military directly. One issue here is that, while the company has around 600 distribution contracts of indefinite term with manufacturers, these contracts can be terminated without cause upon just thirty days’ written notice. The company’s ten largest manufacturer customers represent ~43% of the military segment’s fiscal 2011 sales. The loss of any one of these could occur on short notice and greatly impact NAFC’s military segment operating performance (which disproportionately accounts for NAFC’s profits).
I am also a bit concerned about the company’s retail segment, with its 46 company-owned grocery stores. Groceries retailing isn’t a business you dip your toe into. They are competing against the likes of Wal-Mart (NYSE: WMT), Kroger (NYSE: KR) and Supervalu (NYSE: SVU), which have stores in the thousands and the focus and capacity to outgun smaller retailers. This segment is the least profitable (both relative to revenues and assets) of the company’s three segments. It has also suffered the greatest decline in revenues over the last several years, predominantly due to the expansion of regional supercenter grocers into NAFC’s retail markets.
Overall, NAFC appears to be a solid free cash flow generator with its crown jewel being its military business. It would be great to see the company sell off its grocery stores, free up that working capital and generate cash from the sale of those assets, and then use that cash to further reduce debt and purchase shares. Furthermore, with the shares as cheap as they are (relative to free cash flow), it seems that the company would be better off putting a hold on its dividend in favour of aggressively repurchasing shares.
What do you think of NAFC?
Author Disclosure: None