Kroger Stock Price Dip Provides Opportunity

  • We are seeing inflation in energy markets. This will help Kroger's revenue growth this year.
  • Simple Truth brand continues to grow from strength to strength. It may be a blessing in disguise that the Fresh Market wasn't acquired.
  • Kroger is gaining market share in groceries. Kroger is a good long-term investment option around $35 a share.

Kroger (NYSE:KR) is now down almost 9% year to date which is in direct contrast to Walmart (NYSE:WMT), which is up 10%+ this year. Kroger's stock has suffered recently due to a revenue miss in its recent set of earnings plus guidance this year of same stores growth of 2.5% to 3.5% which was lower than what the market was expecting. However, Kroger finished off the year gone by with top-line growth in every quarter, which was something many of its competitors could not do. Sales grew to $26.19 billion in the fourth quarter with the full year tally at $109.83 billion. Even if the retailer achieves same stores growth of well over 3% annually, this growth rate will still be almost double the industry average. Therefore, you are looking at a stock with meaningful top line growth priced in, implying that the shares could be a little bit rich at present.

The Kroger stock is now trading at an earnings multiple of 18.8, which is well above its 5-year average. However, one can't ignore the fundamentals here. The retailer's top line is up over 40% over the last 10 years, and as its private label products continue to gain traction, I see operating margins reaching 3.5% before long. Analysts are estimating earnings per share of $2.24 this year on revenues of $166.57 billion. Next quarter will be crucial where an EPS of $0.69 on revenues of $34.82 billion is expected. The top line figure would still be a 5.4% increase compared to the same quarter a year ago, which is what investors need to take into account. If the selling in this stock is not done, Kroger will soon find a floor due to its top and bottom line growth. Here are 3 strong reasons why you should consider this retailer on a pullback.

Firstly before you consider ditching this stock, look at its strong fundamentals over a 10 year period.

Years Of Dividend Increases 9 Years - Pass
Free Cash Flow $1.4 billion (10-Year Trend Is Up) - Pass (Very Important For Dividend Investors - Dividend Yield Currently Is 1.1%)
Revenues $109.83 billion (10-Year Trend Is Up) - Pass
Profit Margins 3.3% - (10-Year Trend Is Flat) - Pass
Price History of the stock Up 266% in the last 10 years excluding dividends - Pass
Healthy balance sheet Total assets = $31.9 billion (10-Year Trend Is Up) - Pass
Competitive Advantage
  • Cost Advantages
  • Private Label Brands
  • Consumer Analytics  - Pass
Resistant to recessions? Revenue Not Adversely Affected In The Recession of 2008 - Pass

So the one metric that the street is definitely watching is the retailer's operating margin which is flat at best over the last 10 years. Furthermore, as the chart shows below, revenue growth has been weak (compared to historic numbers) over the past few years, but this metric is closely aligned with the price of gas, which has been sliding since June 2014. Nevertheless, more recently, the price of gasoline has started rising sharply in the US which will mean more top line growth for Kroger this fiscal year. Fundamentally, as the above metrics show, this retailer is stable. Revenue increased last quarter by 3.8% but if we exclude fuel, the top line actually increased by 6.5% and 4.4% if we take out the Roundy's acquisition. Therefore, as oil prices continue their ascent, they will act as a nice tailwind for revenue growth in 2016.

Secondly, Kroger is definitely pursuing more organic food offerings and it makes sense given the outstanding success of its Simple Truth brand which reached sales of $1.5 billion in 2016 (up $200 million over the previous year). Organic, natural and fresh foods are definitely in a growth phase and Kroger is determined to capitalize with the Simple Truth brand, which is about to be pitched as a full lifestyle offering (baby care and household products, etc). The retailer's Mariano's chain of stores which was part of the Roundy's deal brings more fresh offerings to the table and the roll-out of Kroger's own store (Main & Vine) pushes further into the fresh and organic market. Furthermore, the Fresh Market is finally going to be bought by Apollo and not Kroger which is good news in my opinion. Analysts believed that Kroger would have bid hard for the Fresh Market, as the latter has 42 stores in Florida, whereas Kroger only has one at present. However, too many acquisitions in a short space of time can bring integration risk. Kroger is already working through the integration of Roundy's into its company and this will take time to ensure maximum return on investment. More opportunities will come for Kroger down the line.

Thirdly Kroger seems to be taking market share off Wal-Mart in the groceries division which is crucial to revenue growth stability. Statista reported in 2014 that Wal-Mart controlled 24.5% of the groceries market and Kroger just under 13%. However, last year Kroger saw top line growth whereas Wal-Mart saw more than $3 billion shaved off its sales. Furthermore, with groceries supplying well over 50% of revenue to both retailers, it stands to reason that Kroger is gaining market share here, which is bullish for growth. Moreover, Kroger's technology initiatives (Click-list, Vita-cost and Harris Tweeter, etc) will ensure a seamless experience and repeat business in this hugely competitive sector.

To sum up, Krogers's guidance for 2016 was the main reason the stock tanked recently, but I believe it will be short-lived. When the market gets used to peer leading growth, it expects more of the same which Kroger believes it may not be able to deliver this year. However, we have already seen some inflation in commodity markets and this combined with its fundamentals, the growth in its fresh and organic offerings and the market share it clearly is gaining in groceries bodes well for Kroger. Kroger, in my opinion, doesn't pose much downside risk. Anything around $35 a share should prove a good level for long term investment.

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Comments on this article and KR stock

user profile picture
harshal.patel.1
bearish
Inflation in energy markets is bad. The fact that you call this out as a positive shows you really don't understand retailers.

Gasoline sales are very low margin. Increased fuel prices will lead to higher revenue from gasoline sales but minimal extra profit.This is why real investors focus on sales excluding fuel. Fuel is only there to bring customers into the store.

Higher gas prices take away from consumer spending inside the store where margins are higher.
reply
user profile picture
Individual-Trader
neutral
Rising prices will increase sales. Yes I agree with you that gas is mainly used as a loss leader to get people into the store but value investors will look for positive metrics across all metrics. I do not believe Kroger will lose out by having oil prices rise over the long term
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