AxFood: Should I Stay or Should I Go?

Axfood AB 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 remained also 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 ten years than during the last fifty years. Customer behaviours 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 are 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 four million customers a week so they have a lot of data at their disposal. Managed properly, AxFood can serve better their 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 brilliant and very effective company. 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 P/E is 23 (ten years median about 16), P/B is 10.9 (ten years median about 5) and EV/EBIT is 19.2. On the other hand, P/FCF 14.5 is not so overwhelming and AxFood is highly profitable. The company’s ROE is 41.4%, ROA 13.8% and ROIC for several years between 30% and 50%. Althoug food retail industry is 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 not worrying as AxFood generates a strong cash flow. With a one-year free cash flow it would pay off almost all its debt. Futhermore the company’s Q1/18 was very strong. Store sales growth was almost 10%. Together with strict cost control this growth has results in a higher operating profit and profitability. AxFood has gained market shares and it looks like the company will deliver their 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? Their return on retained earnings from last 10 years and 5 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 conservative 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 strongly changing Swedish retail market.

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