Now that I’ve got your attention, let me walk you through buying a company at a discount to its net asset value. By the way, this is the holy grail of the value investor.
Empire Company is the parent company of Sobeys, one of Canada’s largest grocery chains. Empire also owns a majority stake in Crombie REIT, a publicly traded REIT, as well as Empire Theatres, a cinema chain and some commercial and residential real estate in Atlantic Canada. In 2007, Empire privatized Sobeys, a public company at the time, paying 8 times EBITDA, earnings before interest, taxes, depreciation and amortization. Looking back at this transaction five year later, no question, Empire overpaid for Sobeys. Its two Canadian competitors, Loblaw and Metro are valued at an average of 6.6 times this year’s Enterprise value to EBITDA. Fair enough. But why should Empire as a whole trade at 5 times this year’s Enterprise Value to EBITDA? Neither Loblaw nor Metro is growing any faster than Empire, nor do they have any competitive advantages.
Let’s say the current Sobeys business is worth 6.5 times expected EBITDA for 2012, about the same level as its competitors. This gives you a value of $81 a share for Sobeys. Don’t forget Empire’s ownership of Crombie REIT as well as the movie theatres and its real estate. Some analysts believe that these assets are worth another $12 a share. Then of course you have to strip out Empire’s corporate debt as well as corporate expenses which take you down $10 a share. All in you get a net asset value of 81 + 12 -10 = $83 a share for Empire. Empire is currently trading at $55.50 today, a 33% discount to its net asset value.
So while we wait for the market to value Empire properly, we get rewarded with dividend growth. The company has raised its dividend 16 years in a row, and we expect another dividend increase this summer. Its current yield is 1.6%. If this valuation discount continues further we might expect Empire to spin-out Sobeys to the public, an action Empire has taken before when Sobeys became a public company in 1998.
Disclosure: The author and clients of Baskin Financial own shares in Empire Company