Axfood AB (OSTO:AXFO, Financial) operates a food retail and wholesale business in Sweden. The company's operating segments include Willys, Hemkop, Dagab, Narlivs and Joint-Group.
The Swedish food retail market has long been dominated by ICA, Axfood and Coop, three chain-store operations with a combined market share of 90%. This oligopoly situation has been rather stable over the years and market shares have also remained very stable for a long time. However, now the sector is undergoing inevitable changes. Digitalization, e-commerce, competition from discount chains and changing food habits are putting new demands for everyone involved in competition.
The Swedish Trade Federation forecasts that the industry will change faster in the next 10 years than it has during the last 50 years. Customer behaviors regarding food are changing at an increasingly faster pace. Sweden’s population is being concentrated in the major metropolitan areas. People born outside the country account for a significant share of the population. This has brought an influx of influences and inspiration from other cultures. Food from Japan, the Middle East and Korea is becoming increasingly popular. Customers want flexible solutions, preferring to prepare meals from scratch one day and get help with ready-made solutions the next.
The impact of digitization will be enormous in all industries and for all companies. AxFood has more than 4 million customers a week, so it has a lot of data at its disposal. Managed properly, AxFood can serve better its customers, reducing food waste and being more efficient. And you should bear in mind that the food industry is only at the beginning of digitalization. Online grocery shopping will grow fast. Today many tasks are performed online, and demand is rising for digital services that make life easier.
We should not forget either that sustainability is no longer a narrow issue for a handful of engaged people. Customers are growing increasingly aware of how food production affects our planet as well as our health. AxFood is working systematically to reduce the use of fossil-based plastics both in production and in stores. Issues such as a product’s origin and carbon footprint are becoming increasingly important in the future.
AxFood is a brilliant and very effective company. The company’s track record has been reasonably good in recent years. AxFood can easily be called a Scandinavian quality company. I have owned the company since April 2010. The share price has risen from 51.00 krona to 163.00 krona (CAGR of nearly 16%) and annual dividend from 3.00 krona to 7.00 krona (CAGR of 11%), respectively. Until now, I have to be satisfied with the market-beating results.
But the most important question is, as always, what will be the future of the company? At the moment, AxFood is not the cheapest stock. The company’s price-earnings ratio is 23 (10-year median about 16), price-book ratio is 10.9 (10-year median about 5) and EV/EBIT is 19.2. On the other hand, P/FCF of 14.5 is not so overwhelming, and AxFood is highly profitable. The company’s return on equity is 41.4%, return on assets is 13.8% and return on invested capital for several years has been between 30% and 50%. Although the food retail industry is a low-margin business, AxFood’s margins have been stable and growing.
Last year’s profitability was down slightly due to future investments. At the same time, the company's debt level increased, but it is not worrying as AxFood generates strong cash flow. With one year of free cash flow it could pay off almost all its debt.
Futhermore, the company’s first quarter of 2018 was very strong. Store sales growth was almost 10%. Together with strict cost control this growth has resulted in a higher operating profit and profitability. AxFood has gained market share, and it looks like the company will deliver on its long-term target to grow more than the market with an operating margin of at least 4%.
What kind of future returns we can expect owning AxFood? Its return on retained earnings from the last 10 years and five years have been 22.4% and 27.6%, respectively. The company’s reinvested rate is low because its dividend payout ratio is about 75%, but AxFood generates cash flow effectively, and return on invested capital is high. In addition to this you can expect at least 10% annual dividend growth with a dividend yield of approximately 4%.
You can never be sure of the future, but I will keep my stock position with confidence. I expect AxFood to have a good opportunity to strengthen its position in a strongly changing Swedish retail market.
Disclosure: Long AxFood.
