Ahold Q1, An E-Commerce And Working Capital Analysis

Ahold Delhaize (OTCQX:ADRNY, OTCQX:AHODF) released its Q1 2018 results on the 9th of May. The company showed above average results. Especially the working capital improvements helped the company’s cash flow statement to outperform. At first, I was scared that the improvement of the company’s working capital would lead to a decrease in short term liquidity. This actually was not the case and the company’s current and quick ratio even increased compared to one year ago. On top of the strong cash flow statement, Ahold Delhaize also managed to increase its online grocery sales market share. Therefore, the tumble of nearly 2.5% seemed unjustified, the stock is currently trading on similar levels as prior the earnings release.

I will first give a general explanation of working capital, a metric that is calculated by subtracting current liabilities from current assets. I will then look whether Ahold Delhaize, as result of its recent positive change in working capital, reduced its short run liquidity. I will finish with an online growth comparison between Ahold Delhaize and its closest competitors.

Working Capital

“When not managed carefully, businesses can grow themselves out of cash by needing more working capital to fulfill expansion plans than they can generate in their current state. This usually occurs when a company has used cash to pay for everything, rather than seeking financing that would smooth out the payments and make cash available for other uses. As a result, working capital shortages cause many businesses to fail even though they may actually turn a profit. The most efficient companies invest wisely to avoid these situations.” – investinganswers.com

This quote makes clear how important working capital is for a company. A lack of working capital can make a profitable company go bankrupt. As I mentioned in the introduction, working capital is calculated by subtracting current liabilities from current assets. The metric influences the free cash flow of a company. Therefore, you look at changes in working capital and to a lesser extent to the absolute value of working capital. You do not focus on the cash changes in the current asset. The reason for this is that you can see the changes in cash at the bottom of the free cash flow statement. You also do not take changes in debt into account. Debt belongs in the financing activities section of the free cash flow statement, not in the operating activity section.

An example of a positive change in working capital is a decrease in inventories or accounts receivable. The company is reducing its inventory by selling an x amount of goods, while only buying back an y amount of goods, for x>y. The free cash flow therefore increases, as a result of the company profiting from the full x amount of products sold, while only having to buy back the smaller y amount of inventory.

An example of a negative change in working capital is an increase in accounts receivable. This has a negative impact on the free cash flow, because cash payments from customers are being delayed.

Improving working capital for Ahold Delhaize

Source: Ahold Delhaize Q1 2018 results

Ahold Delhaize improved its working capital by 143 million (346-203). In Q1 free cash flow increased from 244 million to 441 million. Working capital contributed on more than 70% of the increase in FCF.

The positive change was mainly driven by lower inventories and lower receivables. The accounts payable and current liabilities section had a negative impact on the change in working capital. Ahold Delhaize paid its liability holder earlier than it did in the previous period. Paying earlier has a negative effect on cash flow.

As you can see on the balance sheet represented above, Ahold Delhaize did indeed lower its inventories and accounts receivable.

The company also decreased its accounts payable and other current liabilities. You may think that improving your working capital, and therefore lowering your current assets is always a good thing. Lowering current assets improves your free cash flow. However, by lowering your current assets and increasing current liabilities, a company reduces its short-term liquidity.

Two liquidity ratios

To test whether Ahold Delhaize did indeed reduce its short term liquidity, I will use the quick ratio and current ratio. The quick ratio is defined as:

Quick ratio = (current assets – inventories) / current liabilities

The quick ratio is 0.77 for Q1 2018 and 0.64 for Q1 2017.

The current ratio is defined as:

Current ratio = current assets / current liabilities

The current ratio is 1.05 for Q1 2018 and 1.00 for Q1 2017.

For both ratio’s, a higher number points to a better short term liquidity. It is good to see that Ahold Delhaize managed to increase its cash flow by decreasing its working capital, while not putting its short term liquidity in jeopardy.

E-Commerce sales

Ahold Delhaize reported in its highlight section that online sales grew 23.2% at constant exchange rates. This seems like huge growth for the relatively slow growing supermarket environment. You may therefore decide to initiate a position, but you should notice that Ahold Delhaize’s competitors are growing faster in online sales. In the table represented below, I am only comparing sales growth, not absolute growth. The reason for this is that, unlike Ahold Delhaize, not every competitor reports what percentage of revenue comes from online sales.

Online sales growth Total online sales

Online sales as percentage

of total sales

Ahold Delhaize 23.2% 905 million USD 5.1%
Kroger (KR)

90%

Target (TGT) 29% 1.87 billion USD 8.2%
Walmart (WMT) 23%

Source: Author created table

Although not all companies in the table get all their revenue from the US, the table should give an overview of the online sales of the biggest supermarket companies. As you can see, both Target and Kroger are outgrowing Ahold Delhaize. Even though we do not know whether they are growing faster in absolute sales, we do know that they are gaining online market share.

You may ask yourself, why does he put so much emphasis on online grocery sales? The reason for this is that the U.S. online grocery sales are estimated to grow from $71 billion in 2017 to $177 billion by 2022, this represents a 20% compound annual growth rate. As you can see, all four companies in the table represented above grow faster than the estimated 20%. Target and Ahold Delhaize have a small market share and therefore have room to run.

Conclusion

Ahold Delhaize delivered a strong first quarter in which free cash flow increased to 441 million. This increase was primarily driven by improvement of the company’s working capital. Working capital sometimes causes a company to decrease its short term liquidity, this is however not the case with Ahold Delhaize. The company even managed to increase both its quick and current ratio. In its quarterly report, management announced that it wants to keep improving its working capital. I will keep tracking Ahold Delhaize’s current and quick ratio to see if the company does not put its short term liquidity in jeopardy.

Management seemed satisfied with its increase in online grocery sales. However, this increase lags behind two of its three competitors. The 23.2% online sales growth posted by Ahold Delhaize, is however better than the 20% growth in the online grocery sales market. I will keep track of the company’s online sales, because I feel like missing the boat on e-commerce will have a huge impact on the company’s future.

Additional Remark: I am a 20-year old student who started investing one year ago. I write about stocks that fit a millennial portfolio. If you want to be kept up to date, please follow me by clicking on the orange button at the top of this article.

Disclosure: I am/we are long ADRNY.

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.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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