Published September 26th, 2016 by Eli Inkrot
Whether you’re looking for your weekly meals or want to build a passive income empire, an enterprise like Canadian-based Empire Company (EMP.A) can assist in either.
The company’s history dates back to 1963 but its related subsidiaries have now been serving customers for over a century.
Empire operates in two separate businesses: food retailing and investments / other operations. On the retail side Empire runs over 1,800 groceries and fueling stations like Sobey’s, Safeway, Thrifty Foods, Foodland and Lawtons. On the investment side, Empire has a 41.5% stake in Crombie REIT (CRR.UN) and a 40% interest in Genstar.
Here’s how the company lays out its operations:
U.S. based investors may not be familiar with the name, but Empire represents the second largest food retailer in Canada – spanning coast-to-coast in ten provinces with pharmacy, wholesale and fuel offerings to boot.
The company ranks fairly well using The 8 Rules of Dividend Investing. Keep reading this article to learn more about the investment prospects of Empire Company stock.
On September 15th of 2016, Empire released first quarter fiscal 2017 results, for the period ending August 6th, 2016.
Note: all numbers will be in Canadian dollars as a result of the company’s location and operations.
For the quarter sales came in at $6.187 billion, representing a decline of about 1% as compared to the previous year ago period. Adjusted net earnings came in at $73.6 million compared $121.7 million in the previous year, a decrease of nearly 40%. Adjusted earnings per share were $0.27 as compared to $0.44 in the previous period, a 39% decrease.
Notably, the Western portion of the business has been challenging, as the economy is both a core market for Empire and tied to the energy industry, which has been languishing as of late.
For the year ending May 2016, Empire reported net sales that were 2.9% higher – increasing to $24.6 billion. Adjusted net earnings came in at $410 million, as compared to $511 million in the previous fiscal year. And adjusted earnings-per-share came in at $1.50 – down from $1.84 in the previous year.
Also on September 15th of this year, Empire declared a $0.1025 quarterly dividend to be paid on October 31st. This continues a decades-long increase streak to go along with the second straight payment at this rate. Dating back to the early-2000’s Empire has stuck to a “four quarters and raise” method of boosting its dividend, but prior to this the payment schedule was a bit more erratic.
Competitive Advantage & Recession Performance
Empire describes its competitive advantages in the following way:
Basically Empire uses its scale advantage – having a large network – but also works to execute on the store level. So far Empire’s position, profitability and commitment to shareholders has demonstrated a lingering advantage, but of course retail is notoriously finicky and requires constant attention.
Here’s a look at how the company performed leading up to, during and after the most recent recession:
- 2007 earnings-per-share = $1.60
- 2008 earnings-per-share = $1.35
- 2009 earnings-per-share = $1.47
- 2010 earnings-per-share = $1.51
- 2011 earnings-per-share = $1.66
You can see that earnings-per-share went from $1.60 in 2007 down to $1.35 – a nearly 16% decrease – in just one year. If that happened consistently this wouldn’t be the best of news. However, as a one-time event, it’s not the worst scenario.
In the years to come Empire was still increasing its dividend year-after-year. Moreover, eventually you had earnings “snap back” to its pre-recession mark. Although to be sure earnings toady are still more or less in line with what the company previously generated years ago. Still, Empire remains profitable year-after-year. The company is reasonably recession resistant.
Let’s check in to see how earnings and dividends grew over the last decade:
- Earnings-per-share grew by an average compound rate of 3.9% per annum over the last 9 years.
- Dividends per share grew by an average compound rate of 7.4% per annum over that same period.
As a result of those two numbers, we know that the payout ratio must have increased during this period. Indeed, Empire went from paying out just under 20% of earnings in 2006 to now paying out roughly 30% of its profits as cash dividends.
It depends on where you look, but I have seen estimates for the company’s intermediate-term growth in the 4% to 7% range. Given the company’s past record, industry and general caution, something closer to the lower end of that range seems prudent. And keep in mind that a company does not have to grow by 4% next year to average that rate over a longer period.
Valuation & Total Return
Empire has a nice “why invest” slide that the company includes with its presentations:
These are all reasonable points, but I like to start things off by asking a simple question, “what does the current valuation proposition look like?” In asking this question I want to get a baseline assumption, but I also don’t want to be overly optimistic – better to be pleasantly surprised instead of needing excellent performance to justify an investment thesis.
Over the past two decades shares of Empire have traded with an average earnings multiple of around 12. During the last decade this mark has been closer to 13 and only in the last five years or so has the average inched up closer to 14. You could suppose that the valuation will climb to the sky, but I find it much more prudent to have subdued expectations; let’s use 12 times earnings as a baseline.
If Empire were to grow it’s per share earnings by 4% annually, you would anticipate the company earning $1.85 or so after five years. At 12 times earnings this would equate to a future price near $22.20.
It’s conceivable that the dividend could continue to grow faster than earnings as a result of the comparatively low payout ratio. Should dividends grow by say 6% annually, this would translate to an expectation of receiving $2.40 or so in cash dividends per share in the next half decade. Put together, that equates to a total anticipated value of about $24.60.
Now whether or not this appears attractive depends on the current share price offering and your applicable alternatives. If shares are trading at $30, an expectation of $25 five years out certainly is not compelling.
As it stands, today shares of Empire are trading hands around $20 per share. (And notably, shares actually did trade at $30 to start the year.) At that level, and our above starting baseline, this translates to an expected total gain of about 4.3% per annum. Naturally something much better or worse could occur in reality, but as a prudent starting baseline this does not appear exceptionally attractive.
In short, Empire has proven to be a successful operation for decades now. The company turns a profit year-after-year and has rewarded shareholders all along the way. It is a good example of a Canadian blue chip stock.
The past growth rate has not been exceptional; nor is the expectation for the future growth rate. Investors could still do well (for instance if a bit more growth formulates or if the P/E ratio remains in the mid-teens rather than the low-teens).
However, the starting dividend yield is more or less average. The valuation does not appear overly compelling on a historical basis, but the company’s stock does appear undervalued today relative to today’s elevated price-to-earnings ratios which are a result of rising interest rates.