- Operating margins continue to expand through penetration of private label products.
- The investment in Lucky Market was a shrewd move in a sector (natural and organic) that is growing quickly.
- Plenty of research has been done on the Click-List initiative. Curb-side collection of groceries will grow fast at Kroger.
When I evaluate a stock, the main fundamental metrics I concentrate on are earnings, debt and cash. If three of these metrics are sound (positive earnings, low debt and cash on the balance sheet) and can be combined with a low valuation with respect to its peers and its historic average, then you are definitely looking at a company with upside potential. Kroger (NYSE:KR) hasn't been taken by the market all that well this year. The stock is down 17% year to date despite releasing an impressive set of earnings for its first fiscal quarter of 2017.
Earnings again came in ahead of estimates (EPS of $0.70 a share) and although its top line came in a bit light compared to expectations, Kroger has now achieved 50 consecutive quarters of positive same stores sales growth - a feat in itself. The punishment of the stock has meant that Kroger is now trading at $34.71 a share with an earnings multiple of 16.7 which is below both its historic earnings multiple and the industry's average. Its fundamentals are just too strong to see it decline (especially as equity markets continue to rise). Here are 3 strong reasons why this stock still remains a strong hold in my view.
Market is projecting slower sales and earnings growth
To me, its looks like the market is pricing in smaller growth levels in revenue and earnings and this is being reflected in the share price. Furthermore, analysts are predicting an EPS of $0.45 for this quarter which is only $0.01 higher than last year same quarter, which on the surface may look disappointing in terms of growth rates. However, Q2 last year was a huge quarter for the company which must be taken into account when Kroger announces its second quarter earnings this year.
Furthermore, I like the trajectory operating margin is taking and I can only see this expanding over time as the company will continue to put its own brands (higher margins) into the mix. We can see this already with how the company is pushing its Simple Truth brand into household and personal care products. Up to now Kroger's brand had been built from the edible part of the store. However, now that Kroger's customers trust the brand, the company has moved into non edible categories to take advantage of the brand and obviously they are higher margins. The chart below shows how Kroger has lifted operating margins to 3.5% in its latest quarter. More private label penetration will improve this metric even more.
The Lucky Market Investment Will Be A Success
Kroger isn't foolish enough to push its private label brands too fast as it knows it needs proven quality goods to ensure it gets the broadest range of customers through its doors. That's why its recent partnership with Lucky Market will put proven goods on Kroger's shelves which again ties into Kroger's overall strategy which is this. Any corporate brand that is not giving Kroger the margins it desires must be eventually shelved by a private label brand or a brand like Lucky Market (which Kroger is now heavily invested in). Retail is a ruthless business. Expect whatever organic and natural offering which is most profitable for the company to be quietly pushed to customers. Anything that falls short will again be phased out.
Plenty Of Planning And Research Has Gone Into Click-List
Click-list (Krogers online pick up service) is also projected to increase volume significantly in the near term as the company opens up new stores to the service. I really like how Kroger has set up this division (which will be run independently from the stores) so efficiency and speed should really come to the fore here. Kroger has always been ahead of the curve when it came to monitoring digital activity of its customers so I expect the new stores that will provide this service to have ample demand from its customers. Furthermore the company will use its current customers to promote its Click-list service in stores where it is currently not available by stating "Not enough of you are buying online so spread the word!" Therefore expect the designated staff, speed and easy to use website to be the key ingredients of success with this initiative here.
To sum up, Kroger may not be an outright buy at present but it has too may things in its locker for it not to be a strong hold at present. Operating margins continue to increase, Click-list is about to go all out and the "Lucky Market" investment will strengthen its brand in natural and organic foods. Not the time to sell Kroger here.