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Cleanup in Aisle 2: Debt Pressures Roundy's and Safeway

Tickers in this article: AMZN FDO IMKTA LMKTA RNDY SWY WAG WMT
NEW YORK ( TheStreet) -- Debt, when acquired at a low cost and invested to yield high profits, can be very beneficial for a publicly traded firm. But when there is excessive debt, the potential for a collapse in the stock price is troubling. That is especially true in challenging periods for companies in low margin industries that pay high dividends, such as Roundy's , Safeway and Ingles Market .

Due to the bull market, each of those companies is up significantly for 2013. The stock price has more than doubled for Safeway this year. For Ingles Markets, the rise has been more than 60% since the first of the year. Over the same period, Roundy's is up nearly 120%.

Just as high as the stock price rises for these companies are the levels of debt for each. The debt-to-equity ratio for Roundy's is 3.34. That means that for each dollar of equity, it required $3.34 in borrowing for Roundy's. The debt-to-equity ratio for Ingles Market is 2.34. For Safeway, it is 1.74.

By contrast, the debt-to-equity for Wal-Mart , the biggest grocer in the United States by sales, is 0.80, less than half that for Safeway. The average debt-to-equity ratio for the industry is 1.74.

In addition to the claim that debt payments has on the cash flow, Safeway, Ingles Market and Roundy's also pay an unaffordable dividend that is much higher than the sector average of 1.20%. The payout ratio for Ingles Market is over 173% for a dividend of 2.43%. That is clearly unsustainable.

Roundy's has a high payout ratio, too, for its 5.16% yield: There have been dividend cuts in the past. Safeway has a dividend payout ratio of 31.70%, which is modest, for its dividend of 2.26%, which is almost twice the industry mean. But Safeway has also sold assets to raise cash.

There are neither the profits nor the needed cash flow growth needed to responsibly support these dividend payments.

For each company, the five-year sales growth rate is also below the industry average of 3.05%. The profit margin for Safeway is 1.70% with a negative sales growth rate for the last five years of 0.15%. The growth rate for Ingles Markets over that period was 3.46% with a profit margin of 0.50%. For Roundy's, it was a 0.50% growth rate for the past five years as it is presently losing money at a 1.5% rate.

As a result, the cash flow growth has been anemic for these grocers, which can be fatal in a low profit margin industry with high capital costs.

This all shows up in the return on equity, one of the most important indicators for Warren Buffett, according to his biographer, Carol Loomis. The average return on equity for a member of the Standard & Poor's 500 is around 15%. For Wal-Mart, it is 23.50%. Safeway has a return on equity of 19.31. It is only 4.37% for Ingles Markets. Roundy's has a negative return on equity of 26.89%. It is obvious why Warren Buffett is a major shareholder of Wal-Mart's. However, all of the stock prices for the grocers are near 52-week highs.