- Kroger has market share growth in majority of its geographies and continued same-store sales increase.
- Kroger is increasing its Return On Invested Capital (ROIC) along with increasing capital expenditures.
- Consistent and continued growth in private label products increases margins. Kroger is a buy.
Following the Kroger (NYSE:KR) Q4 and 2015 fiscal year earnings release on March 3rd, the stock dropped 7% followed by an additional 2.5% decrease the following day after the company missed revenue expectations. Investors overreacted to this miss. Kroger is still the best grocer and general merchandise retailer due to it's continuing market share growth, ability to scale return on invested capital and increasing private label product share.
Kroger Market Share Is Improving
Kroger CFO J. Michael Schlotman stated the company increased overall market share by 40 basis points as measured by Nielsen Point of Sale Data.
Of the 20 geographies that Kroger operates in, market share increased in 17 markets, remained flat in 2 markets and decreased in only 1 market. Kroger is gaining market share in the industry. How is the company performing versus peers Walmart (NYSE:WMT) and Target (NYSE:TGT)?
In Q4 2015, Kroger once again grew same-store sales faster than either Wal-Mart or Target. Kroger has increased same-store sales now for 49 consecutive quarters, over 11 years.
Kroger is continuing to win against its largest peers Wal-Mart and Target. Excluding the recently acquired Roundy's, Kroger CEO W. Rodney McMullen states that same store sales growth guidance for FY 2016 is in the 3-4% range versus zero for Wal-Mart (no guidance was released for Target). Kroger continues to outperform its peers and will likely continue to do so in 2016.
Assuming 1-2% price inflation, Wal-Mart and Target are barely increasing same-store sales excluding inflation whereas Kroger is increasing same store sales by nearly 2%.
Kroger's revenue miss was not due to the company losing ground to rivals; it was due to deflationary prices in deli, seafood and meat. CFO Schlotman stated that meat department "deflation..allowed prices to return to levels where more customers can re-enter the category or increase their purchases. As a result of strong tonnage, the meat department had a great quarter with strong FIFO gross profit dollar margin growth. This is what we often refer to as good deflation."
Though Kroger missed revenue expectations due to deflation, the company is still outperforming its peers. This is positive news for investors, not negative.
Increasing Capital Expenditure Can Be A Good Thing
During the investor call, Karen Short from Deutsche Bank Securities inquired as to why capital expenditure guidance for 2016 was set to increase by nearly 27% versus 2015. In 2012, Kroger began executing a fill-in market strategy to increase square footage and store penetration in new and existing markets. Capital expenditures were employed to open new locations, expand existing stores and acquire competitors. In the last two years, Kroger acquired Harris Teeter's, Roundy's, Hiller's and others. Consistently increasing capital expenditures may alarm investors but that should not be true with Kroger.
Even as Kroger has increased capital expenditures with its fill in strategy, the company has also consistently increased its return on invested capital (ROIC). While capital expenditures in 2016 are set to increase to over $4 Billion, Kroger has shown that the company can manage capital well with consistently increasing return on capital invested.
The second reason investors need not worry about the large Cap-Ex increase is due to the allocation of the capital. Kroger is investing to expand into new geographies, experiment with new store formats and to transition to a more blended online and physical sales mix. To increase their geographical presence, Harris Teeter's recently entered the Washington, D.C./Baltimore area. Kroger opened a new concept store called Main & Vine in Seattle that combines local, specialty and everyday products, all at affordable prices. To target lower income customers, Kroger has been experimenting with its no-frills Ruler stores to understand how to optimize ROIC in that market. These stores may one day compete with Aldi's and Lidl. ClickList, the online shopping technology developed by Harris Teeter's has expanded from one to seven markets.
Kroger has shown it can deliver a higher return on invested capital while investing in geographic expansion, new store formats and e-commerce.
Positive Shift In Product Mix
William Bias touched upon this topic in his earnings review of Kroger on Amigobulls, and I'll provide more color on it. In 2015, private label contributed $20 Billion in revenue. Sales of private label products have significantly higher margins for retailers than sales of branded goods. According to the Food Marketing Institute, retailers earn a 35% margin on private label sales and only a 28% margin on sales of branded goods. The $20 billion in private labels sales is more meaningful when the growth trend is analyzed.
In every fiscal year since 2013, Kroger has consistently increased the dollar and volume share of private label products. In 2015, private label goods accounted for 29% of unit volume and 26.2% of revenue excluding pharmacy and fuel. This consistently increasing percentage of private label sales has led to increasing operating margins.
In 2015, Kroger continued to increase market share (see the first paragraph) while increasing margin through a strong merchandise mix. Increasing operating margin while increasing sales is very difficult and investors should cheer the continuation of this trend. It is worth noting that Kroger's largest private label, Simple Truth, will be expanding into new categories. CEO McMullen announced that Simple Truth has become a lifestyle brand with expansion into household, personal and baby care product categories.
Investor's overreacted when Kroger missed revenue expectations last week. Though deflationary prices led to reduced revenue, Kroger increased its market share while continuing to outperform peers. Kroger increased its return on capital invested while increasing capital expenditures and increased the share of private label sales. Kroger continues to outperform the industry and will likely remain a top investment for years ahead.