Empire Company Stock: An Undervalued Core Business

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Empire Company (TSE: EMP.A) the main activities are food retail, investment and other activities. The Food Retailing division operates through Sobeys, a subsidiary of Empire, and accounts for nearly all of the company’s revenue.

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 company with a measurable competitive advantage.

Empire Company has a competitive advantage

There are several ways to quantify a company’s competitive advantage using only its income statement. The first method is to calculate the Earning Power Value (EPV) of a company.

The value of earning power is measured as adjusted EBIT after tax divided by the weighted average cost of capital, and the value of reproduction (the cost to replicate/replicate the business) can be measured using the total value of assets of a business. If the earning power value is greater than the reproductive value, then a firm is considered to have a competitive advantage.

For Empire, the calculation is as follows:

EPV = Adjusted Earnings EPV / WACC
$17,840 million = $1,338 million / 0.075

As Empire has a total asset value of $12,865 million, it can be said that it has a competitive advantage. In other words, assuming no growth for Empire, it would take $12,865 million in assets to generate $17,840 million in value over time. Please note that the figures above are in USD.

The second way to determine if a company has a competitive advantage is to look at its gross margin, as it represents the premium 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, new entrants will eventually take market share away from it, causing gross margins to decline over time due to the price war.

In the case of Empire, its gross margin has remained stable over the past few years, hovering around 24-26%. Therefore, its gross margins indicate that a competitive advantage is also present in this regard.

Empire Company is undervalued

To value Empire, I will use a one-step DCF model because its free cash flow is 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)

Therefore, I estimate the fair value of Empire to be approximately C$49.45 under current market conditions. With the stock price at C$40.42, there is a decent margin of safety.

Analyst Recommendations

Empire has a Moderate Buy consensus rating based on four purchases and two reservations given in the past three months. Empire Company’s average price target of C$48.67 implies 20.4% upside potential.

Final Thoughts

Empire is a solid company with a measurable competitive advantage. Moreover, it is currently undervalued, even using a one-step DCF model. As a result, investors may consider reviewing the stock.

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