Ahold Delhaize: A Weak Q1, But Things Are Looking Up

Ever since completing the acquisition of Belgian supermarket chain Delhaize, Ahold (OTCQX:ADRNY) (OTCQX:AHODF) has been able to continue to outperform expectations and is now on track to generate approximately 500M EUR in synergy savings in the current quarter which once again emphasizes how important the acquisition of Delhaize (OTC:DHLYF) was for Ahold’s profit and cash flow engine. And considering Ahold paid just 11B EUR for Delhaize (by issuing approximately 4.75 of its own shares per share of Delhaize), generating half a billion in synergy benefits per year provides for a very appealing return on investment.

Source: Yahoo Finance

Ahold is part of the AEX index in Amsterdam, and as its trading volumes in the Netherlands are clearly superior to the US volumes, trading in Ahold stock using the Euronext Amsterdam facilities is a clear no-brainer. The ticker symbol in the Netherlands is AD, and the average trading volume is 4M shares per day. The current market capitalization is almost exactly 22B EUR.

Ahold is also part of the iShares MSCI Netherlands ETF (EWN ) with a 4.47% weight.

A large difference between depreciation charges and capex results in a very strong cash flow result

Ahold saw its revenue increase by approximately 6% in the first quarter of this year, as it reported net sales to the tune of almost 15.9B EUR. As the COGS increased by just over 5%, the gross profit increased by 8.5% to 4.39B EUR.

That’s a good start but unfortunately, Ahold is also subject to margin pressure, just like most of its competitors. And while its gross profit is increasing at a high single-digit percentage, the selling expenses and G&A expenses also increased at a rapid pace as those two elements were roughly 8.5% higher compared to the corresponding period last year. Fortunately, this didn’t have a huge impact on the operating income (which increased by 8% to 675M EUR), but the acceleration of the SG&A expenses will be a key factor I will need to keep an eye on, going forward.

Source: financial report

The company’s total net financial expenses increased by 5M EUR, but this was due to an 8M change in ‘other financial expenses’ during the year. The lease liabilities also increased slightly, but the net interest cost decreased by 10% to just 27M EUR.

The result is a pre-tax income of 550M EUR (which is almost 10% higher than the pre-tax income in the same quarter last year), and an after-tax income of 435M EUR or 0.39 EUR per share. Which is almost 20% higher than the 0.33 EUR in Q1 last year. This substantial EPS increase is mainly caused by the 8% higher net income which was accelerated by an 8% reduction in the company’s share count.

What attracted me to Ahold Delhaize in the past is its ability to convert paper profit from the income statement into ‘real’ cash generation and strong free cash flows. And the first quarter of this year wasn’t any different.

Ahold reported an operating cash flow of 1.36B EUR, but we still need to deduct the 119M EUR in taxes and the 125M EUR in finance expenses which ultimately results in an adjusted operating cash flow of 1.116B EUR. After deducting the 452M EUR in capital expenditures, the bottom line shows a net free cash flow result of 664M EUR.

Source: financial statements

That’s about 50% higher than the reported net income, and the difference could be entirely explained by Ahold’s lower capex (452M EUR) compared to the depreciation charges (676M EUR). Keep in mind the company has been guiding for a full-year capex of around 2B EUR, so the first quarter was a little bit capex-light.

The combination of a dividend and repurchasing stock appears to be a good blend

During the first quarter, Ahold Delhaize spent 307M EUR on buybacks and 417M EUR on repaying lease liabilities for a total cash outflow of 724M EUR. That’s indeed higher than the generated net free cash flow but Ahold wasn’t overspending. Additionally, the Q1 payment for lease liabilities was more than 10% higher than last year’s lease payments.

First of all, the lease liabilities are a direct consequence of the new IFRS16 rules and are now required to be reported as a financial cash flow instead of an operating expense. Perhaps that’s fair, but it does confuse some investors as a lease payment is a payment ‘towards’ something as the lessee usually ends up with ownership of the asset after the lease term (when it’s a ‘financial’ lease).

For 2018, Ahold declared a dividend of 70 cents per share, which will cost the company approximately 850M EUR based on the current share count. This indeed means that after deducting the lease expenses from the operating cash flow, almost the entire free cash flow (90%) will be used to cover the dividend. But again, some of these lease expenses are directly correlated to further growing the business, and should not be considered sustaining. And this means the company could continue to hike its dividend, as it has done in the past several years.

Source: Dividendpagina.nl

In January, Ahold also announced a 1B EUR share buyback program, and it remains well on track to complete this buyback program before the end of this year, so it doesn’t look like Ahold will be slowing down its buyback pace at all. Fortunately, the lower the company’s share price, the bigger the bang Ahold gets for its buck as it can repurchase more stock at a lower average price per share. I now expect Ahold to end the year with a net share count of approximately 1.185B shares. Should the dividend increase by 1 cent to 71 cents per share, Ahold will need approximately 840M EUR to cover the dividend. Doable, considering Ahold’s remaining three quarters are usually better than the first quarter (last year, for instance, Ahold generated less than 24% of its full-year revenue in the first quarter and in excess of 26% in the final quarter of the year).

The expected lower lease payments and higher cash flows were also confirmed during Ahold Delhaize’s Q1 conference call:

I think – I know there are some timing issues in the expenses in the first quarter, and I’d expect to see it more in line with the full year numbers as we go through the next three quarters both in terms of the lease expense particularly, but also in terms of the total free cash flow reaching the level that we’ve guided to.

Investment thesis

Ahold originally expected to generate a free cash flow result of 2B EUR, but had to revise this to 1.8B EUR when it published an update in April. It will be interesting to see if their definition of free cash flow will include all relevant parameters (including the lease liabilities which could be considered a ‘swing factor’ for the free cash flow result). Considering the balance sheet contains about 9.2B EUR in ‘non-current financial liabilities’ which contains these lease liabilities, a quarterly payment of almost half a billion Euro makes this a self-correcting issue. In 5 years from now, all relevant lease payments will have been made (unless, of course, Ahold enters into new lease agreements).

The total net debt + non-current financial liabilities + the pension deficit as of the end of March was 12.66B EUR (and only a quarter of this consisted of ‘real debt’ with the balance caused by lease obligations and a relatively small pension deficit) so perhaps Ahold should be conscious about how it’s spending its cash. Let me be clear: there’s currently no issue whatsoever, but making the lease payments and covering the dividend doesn’t leave too much room for additional aggressive share buybacks beyond the current 1B EUR program.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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