The third-quarter results for Ingles (Nasdaq: IMKTA) had me thinking more of a bare-shelved, Soviet-era supermarket than of the thriving retailer it resembled a year ago. But the North Carolina-based regional grocery chain can't blame a communist government for its woes -- the weak economy and an expensive debt refinancing did most of the damage.

Now, taken in context, the quarter wasn't quite as bad as it looked. Net income plummeted by 71% to $4.7 million, or $0.19 per share, on a 1% drop in revenues to $826.8 million. But a year ago, gasoline prices were higher by about $1.50 per gallon, and that difference represents most of the weakness in Ingles' top line. In fact, excluding gas revenues, net sales rose by more than 5%, and customer transactions increased by nearly 8%.

So why the big drop in profits? If it seems that something isn't adding up, you're right.

Money in the bank
Ingles' leadership decided that the time had come to refinance its existing debt. So the company tapped the high-yield debt market -- as Wendy's/Arby's Group (NYSE: WEN) and Rite Aid (NYSE: RAD) have recently done -- in issuing $575 million in eight-year notes, though a private placement priced to yield about 9.5%.

Ingles used most of that cash to redeem its outstanding 2011 notes, as well as other secured debt and lines of credit. By repaying its 2011 debt early, the company had to take a $10.2 million loss that had a significant impact on its bottom line.

Looking forward
It's clear that Ingles is trying to build a newer look to stand out from competitors such as Whole Foods Market (Nasdaq: WFMI) and Kroger (NYSE: KR). Since the start of fiscal 2008, the chain has added 22 new, remodeled, or relocated stores. But all of that activity has squeezed operating margins, since costs are high while new operations get up and running.

Ingles has no plans for further expansion in 2009, but management said it continues to carefully evaluate future projects. But the company's competitors aren't standing still, and unless Ingles can build a stronger image of its own, it could experience big problems down the road.

Is it a smart buy?
Making an investment in a grocery-store chain takes courage. With razor-thin profit margins, the industry is ultracompetitive.

Threats to Ingles don't come only from well-known publicly listed grocers such as Safeway (NYSE: SWY). Privately held retailers such as Publix are also lying in wait to lure its customers away. Meanwhile, behemoths such as Wal-Mart (NYSE: WMT) can easily undercut a small chain of Ingles' size. That's enough to keep me away from Ingles stock.