Empire Company’s (TSE: EMP.A) key businesses are Food Retailing, Investments, and Other Operations. The Food Retailing division operates through Empire’s subsidiary Sobeys and represents nearly all of the company’s income.
This segment owns, affiliates, or franchises more than 1,500 stores in 10 provinces under retail banners, such as Sobeys, Safeway, IGA, Foodland, FreshCo, Thrifty Foods, and more.
Empire is a profitable, undervalued business with a measurable competitive advantage.
Empire Company Has a Competitive Advantage
There are a couple of ways to quantify a company’s competitive advantage using only its income statement. The first method involves calculating a company’s earnings power value (EPV).
Earnings power value is measured as adjusted EBIT after tax, divided by the weighted average cost of capital, and reproduction value (the cost to reproduce/replicate the business) can be measured using a company’s total asset value. If the earnings power value is higher than the reproduction value, then a company is considered to have a competitive advantage.
For Empire, the calculation is as follows:
EPV = EPV adjusted earnings / WACC
$17,840 million = $1,338 million / 0.075
Since Empire has a total asset value of $12,865 million, we can say that it does have a competitive advantage. In other words, assuming no growth for Empire, it would require $12,865 million of assets to generate $17,840 million in value over time. Please note that the figures above are in USD.
The second method to determine if a company has a competitive edge is by looking at its gross margin because it represents the premium that consumers are willing to pay over the cost of a product or service. An expanding gross margin indicates that a sustainable competitive advantage is present.
If a company has no advantage, then new entrants would eventually take away market share, leading to decreasing gross margins over time due to pricing wars.
In Empire’s case, its gross margin has remained flat in the past several years, hovering around 24-26%. As a result, its gross margins indicate that a competitive advantage is present in this regard as well.
Empire Company is Undervalued
To value Empire, I will use a single-stage DCF model because its free cash flows are volatile and difficult to predict. For the terminal growth rate, I will use the 30-year Government of Canada bond yield as a proxy for expected long-term GDP growth.
My calculation is as follows:
Fair Value = five-year average FCF per share / (Discount Rate – Terminal Growth Rate)
C$49.45 = C$3.12 / (0.095 – 0.0319)
As a result, I estimate that the fair value of Empire is approximately C$49.45 under current market conditions. With the share price at C$40.42, there is a decent margin of safety.
Analyst Recommendations
Empire has a Moderate Buy consensus rating based on four Buys and two Holds assigned in the past three months. The average Empire Company price target of C$48.67 implies 20.4% upside potential.
Final Thoughts
Empire is a solid business that has a measurable competitive advantage. In addition, it is currently undervalued, even when using a single-stage DCF model. As a result, investors may want to consider looking into the stock.
