DELHAIZE: A contrarian stance - upgrading to BUY

Reasons behind the upgrade 
The stock is trading 25% below its 2011 peak following two consecutive quarterly EBIT misses. Amid growing uncertainty about the global economic outlook, we take a contrarian stance and upgrade the rating from Accumulate to Buy because a recession is not necessarily bad news for a food retailer. For example, in 2008, Dehaize’s gross margin improved by 6bp on the back of increased private label penetration as consumers traded down and REBIT (excluding an extra sales week) rose by 3.4% at identical exchange rates. Note that Delhaize (44,98 EUR, 0,49%) America is aiming at 35% private label penetration by 2013 versus 26% at the beginning of this year. The launch of MyEssentials, the value brand, across the US stores should also reinforce Delhaize America’s price perception. 

Delhaize America’s EBIT margin came under pressure in 1H11 as a result of input cost inflation combined with price investments. We anticipate however that this pressure will ease in a recessionary environment. Unilever’s management indicated already that for 2H11 they expect selling prices to stabilize at the level seen in 2Q11or to rise only slightly above it. 

The 200 Food Lion stores that were re-launched early May reported high-single digit volume growth. The repositioning of the entire Food Lion network will substantially be competed by the end of 2012. A successful turnaround of Food Lion should have a positive impact on the share price evolution over the next two years. Note that Food Lion is Delhaize’s main banner, with about 46% of the group’s store count at the end of 2Q11.

Revised forecasts
Our EPS estimates for 2011, 2012 and 2013 have been revised downwards by respectively 6%, 8% and 9%. Target (47,27 USD, 1,22%) price is lowered from € 65 to € 60. We consider the new estimates to be conservative especially in the event of a successful turnaround of Food Lion and a swift integration of Delta Maxi.

Valuation
The stock is trading at extremely low valuation multiples based on our revised forecasts. In 2008 and 2009 the stock was trading at P/Es of respectively 9.6 and 9.3. The current share price reflects fears of a significant drop in margins. A P/E of 9.0 implies an EBIT margin of 4.1% in 2012. In other words an EBIT margin contraction of 60-70bp versus the level achieved in the downturn years 2008 and 2009 is already priced in.