Smoky Mountain Majesty

JON SPRINGER

Ingles Markets may be the country's most underestimated supermarket chain.

While Wal-Mart's march through the rural South crushed one food retailer after another, Ingles not only survived but grew stronger. Even in a rebounding industry, Ingles' comparable-store sales gains are noteworthy: 11.6% in fiscal 2006, following annual gains of 6.5% and 6.7%, respectively.

Tightly held by its founding family and seldom discussed — Ingles officials declined interview requests for this article — word has finally reached the investment community, which patiently but aggressively last year began accumulating shares of slow-trading Ingles stock. Today Ingles' stock price is hovering near its highest level since the shares began being publicly traded 20 years ago, with the price increasing by more than 120% over the last year. Ingles' market capitalization has reached nearly $1 billion.

The Asheville, N.C.-based company, which runs approximately 197 supermarkets in four Southeastern states and recorded annual sales of $2.6 billion in fiscal 2006, is driving growth through its strengths in real estate and merchandising, observers say. Its stores tend to be in good locations in the small towns and suburbs where it does business. And because more than 70% of Ingles' sites are owned by the company, expansion into new services — gasoline, organic produce and, most recently, convenience stores — is sparking sales growth faster than its competitors can keep up and winning battles for shoppers who desire convenience and a shopping experience distinct from that of Wal-Mart.

“The thing that sets Ingles apart from its competitors is that, like Bashas' and Wegmans, it combines the best of family and professional management that really cares about the customer,” Burt P. Flickinger III, managing director, Strategic Resource Group, New York, told SN. “In the Southeast, where the supermarket sector has experienced so many bankruptcies and liquidations from Wal-Mart hitting the region so hard, Ingles has weathered the storm and built its business by constantly investing in its stores and infrastructure to make the business better.”

its own landlord

Ingles was founded in 1963 by Robert P. Ingle, who remains the company's chief executive officer, largest shareholder and guiding force. Ingle as of last Sept. 30 owned 87% of the combined voting power and 49% of the outstanding Class A and Class B stock shares.

Ingle, whose father ran a small grocery store, started his own business after reportedly being turned down for a managerial role at Colonial Stores, his employer at the time. Using a $20,000 loan from supplier Merchants Distributors Inc., Ingle opened a 5,000-square-foot store in Asheville. He added two locations and soon was making enough money to purchase six Colonial stores in western North Carolina — including the one that wouldn't promote him, Ingle told SN in a 1978 article.

That purchase, in 1968, began Ingles' rise as a regional power. Within a decade it was self-distributing and later — by 1982 — running its own dairy (Ingles still purchases frozen foods and other items from MDI, while MDI is one of Ingles' largest dairy customers and a small investor).

All of Ingles' stores are located within 250 miles of its Asheville headquarters. Most were built on land the company acquired years ago in sleepy Southeast markets awaiting the kind of growth they are experiencing today. “We like our stores outside the big cities,” Ingle said in the 1978 SN interview. “For example, in Georgia we have stores in Toccoa and Blue Ridge, yet we have no intention of hitting the Atlantas or Augustas. There is just no reason to. There are enough big chains in the cities to keep customers happy.”

Ingles still runs stores in Toccoa and Blue Ridge, and still hasn't expanded to Augusta or Atlanta. And because Ingles has operated stores in these small markets longer than its competitors, it owns the prime locations there.

Anthony Smith, a debt analyst at BNP Paribas, New York, estimated that Ingles' market areas saw overall population growth of 7.3% between 2000 and 2004, compared to a 4.3% national average.

As of last September, 56 Ingles stores were located in company-owned shopping centers, and 80 freestanding Ingles stores were sited on company-owned property. Being its own landlord provides Ingles with lower occupancy costs and, in some cases, rental income. Its most important advantage, however, is the ability to expand and add services. It is no accident that Ingles' recent sales growth is attributable to both.

“They own their own real estate, which gives them a lot more flexibility in terms of remodeling stores, putting in gas stations and pharmacies,” Justyn Putnam, a stock analyst for Gabelli & Co., Rye, N.Y., said in a recent interview with SN. “They can do all that while their competitors can't.”

There is some speculation that Ingles' real estate underlies some of its recent attractiveness to investors. But company management has resisted calls for sale-leasebacks or other strategies to extract value from its dirt. “They're adamant about the fact that real estate gives them a huge competitive advantage,” Putnam said.

‘publix of the rural south’

Ingles in recent years has been transforming its fleet of conventional food stores to one-stop destinations, including in-store departments such as floral, cards and gifts, books, and pharmacy; kiosks leased to specialty coffee providers; and parking lot fuel stations. Its average store size has grown from 45,454 square feet to 48,657 square feet since 2002, with new stores typically measuring 65,000 square feet.

What hasn't changed with the times is an emphasis on service that observers say provides Ingles shoppers with the feeling they are shopping in a “better” environment than other supermarket retailers. Ingles' largest competitors include Bi-Lo, Kroger, Food Lion, Piggly Wiggly and independent grocers.

“They've become like the Publix of small Southern markets,” Britt Beamer, chairman of America's Research Group, Charleston, S.C., told SN in a recent interview, referring to the Lakeland, Fla.-based supermarket chain famous for customer service. “They have a great selection, and by far the nicest store in most of their markets. They've taken a higher service level position, and gone just a little upscale, over the main competition.”

Ingles at the same time can be priced competitively, noted Flickinger. It is known to run triple-coupon promotions and has long believed in hot prices on the ad flier as a means to drive store traffic. “Ingles has a conscious desire to save the consumer a lot of money,” Flickinger said. “They fight to save on the basket every day in terms of competitive shelf prices and deep discounts on promotional pricing.”

In late 2003, Ingles added a frequent shopper card, which it intends to use to facilitate more-direct consumer marketing, the company said in filings. Around 75% of all food purchases came through the shopper card in fiscal 2006, Ingles said.

More recently, Ingles has offered a cents-off deal on gas purchases with the loyalty card.

“The customer who goes in an Ingles is competitive-price-driven, not lowest-price-driven,” said Beamer. “They don't want to overpay, but they might be willing to pay slightly more for convenience. The competitive shopper might not care about 25 cents if they know they can get every thing they want when they come to shop.”

New departments for organics and expanded prepared food offerings are helping bring margins up, though at 24.8% for fiscal 2006, including gas, Ingles profit margins are tight by industry standards. A low-cost infrastructure helps some: Ingles' selling, general and administrative costs were just 20.5% of sales in fiscal 2006.

“While there's a trend toward higher-end and organic, Ingles is definitely not trying to be a Whole Foods,” Putnam said. “But they are trying to get more higher-margin products into their sales.”

Another avenue for margin expansion is private label, which according to Ingles is underdeveloped as compared to peers. Ingles carries three proprietary lines in a good-better-best arrangement. The main “better” label, Laura Lynn, is named after the daughter of the founder.

new convenience concept

Efforts to expand the space and the services at its stores come with a hefty price tag. Ingles plans to spend $100 million on capital projects during the current fiscal year, after spending around $316 million for the previous five fiscal years. The capital expenditures this year are earmarked for four new replacement stores, four remodels and approximately 16 fuel centers.

Some of Ingles' recent capital spend went toward developing a new convenience store branded iMarket, which Ingles operated along with fuel stations at two locations as of late last year. Company officials have been reluctant to discuss results of the new store, telling analysts in conference calls it was too soon to comment.

As a result of the heavy capital spend, combined with a cash dividend of around $16 million, and payments for interest, taxes and debt service, Ingles consistently shows negative cash flow. According to analyst projections, Ingles will show negative cash flow of $70 million this year. Net income is projected to be around $46 million; EBITDA will be around $186 million on sales of $2.7 billion, according to Smith of BNP Paribas.

“I think it's to the company's credit that they're spending so much,” said Flickinger. “So many other companies try to fake out the Wall Street community by cutting working capital, cutting inventory, cutting cap-ex and not investing back into the business. Ingles takes it as a real matter of corporate pride to invest in store service and labor and profitably drive sales, then invest that back into remodels and renovations and new stores. And I think they will see a tremendous long-term gain as a result.”

Ingles became a publicly traded company in 1987 but rarely attracted the attention of investors quite like it has over the last year. A year ago, Ingles was trading at around six times EBITDA, compared with industry peers trading eight times or more. Traders discounted Ingles for its illiquidity — it was so lightly traded that meaningful stakes could take weeks or months to acquire — and for the fact so much of the voting shares were in control of the founder and chairman, an analyst said.

Then last year, groups like Gamco Investors (of which Gabelli & Co. is a subsidiary) and Greenwich, Conn.-based hedge fund Silver Point Capital gradually assembled stakes. Silver Point, which owned more than 5% at one point but more recently reported a smaller stake, declined to comment. But their interest seemed to spark additional volume and the subsequent spike in the stock price.

Investors in company conference calls have occasionally tried to determine Ingles' plans in regards to its real estate strategy, leading to some speculation that investors were interested in seeing the retailer extract value from its considerable property holdings. But according to Putnam, Ingles won't be persuaded easily.

“They are not at all vulnerable to that [shareholder activism],” he said. “Their founder and management own around 90% of the vote. You can't do anything at the company without them on board.”

At the end of its last fiscal year, Ingles carried total debt of $556.3 million, with $350 million in bonds rated below investment grade by Moody's and Standard & Poor's. But Ingles, according to Smith, is “an absolutely solid credit.” Company officials have indicated a desire to buy back its outstanding bonds shortly and refinance, a move some analysts believe should lower Ingles' overall costs.

opportunistic competitor

It has not been a good era for competitors of Ingles. Bi-Lo, Greenville, S.C., has spent much of the past few years shedding stores, slicing costs and scraping by on a very tight budget. Bi-Lo officials say the chain is ready to grow again but in the meantime its on the selling block. Jacksonville, Fla.-based Winn-Dixie abandoned much of the areas where it competed with Ingles as a result of a bankruptcy. Their struggles relate, in part, to new competition from Wal-Mart supercenters.

Observers praise Ingles for its opportunism in such an environment, making itself the biggest beneficiary of a spate of closings, while improvements in services and perimeter departments win customers from Wal-Mart.

“Ingles won't be at 11% sales gains for the whole decade, but I could see them at a strong 5% same-store rate — or about double or triple the rest of the industry, including Wal-Mart,” said Flickinger.

Others questioned what will follow the improvements to the existing store base, and what if any role Ingles plays in a consolidation scenario.

“Ingles' biggest weakness is, once their target number of stores get improvements, it's not clear what the game plan is after that,” Putnam said. “More competition could hurt, too. They've certainly enjoyed relatively little competition recently, as the result of Winn-Dixie's retreat.”