Grocer Kroger (KR) Thriving in Recession

The Kroger Company (KR) reported earnings this morning before the open and beat consensus estimates for both earnings and revenue. Analysts had called for earnings of $.38 per share but KR beat that by a penny after excluding charges from damages from Hurricane Ike. Kroger is the nation’s second largest food retailer after Walmart (WMT), making it the largest of the traditional supermarket chains. Kroger has benefited from economic weakness that has cash-strapped consumers shopping at Kroger for meals that can be prepared at home instead of opting for expensive restaurant dining. KR shares have sold-off in sympathy with the market of late and, given today’s earnings new, Ockham views the stock as an attractive buy candidate.

Kroger CompanyKroger is grabbing market-share as the economy has slowed. The company’s same-store sales growth was five percent for the quarter and this is a crucial metric for retailers. Kroger already has one of the most prominent footprints of any supermarket chain, with 2,474 stores in 31 states. Kroger is also expanding its offerings as it opens new concept stores. One such design, the “Marketplace” concept calls for stores about twice the size of traditional KR stores and is meant to compete head-to-head with Walmart. Marketplace stores specialize in groceries but also offer many other products. The other concept is called “Fresh Fare” which is similar to a more boutique type of grocer. Kroger Fresh Fare stores will offer higher-end foods and an extensive prepared meals selection. While high-end grocers such as Whole Foods are struggling mightily in this economy, that model has proven to have great potential in a more robust environment. We believe that the slow roll-out of these stores could be a boon for the company when the economy does turn around, as for right now the vast majority of Kroger stores are not of the high-end variety.

The company issued guidance for the year ahead of $1.88 to $1.91, which was an improvement over what had been anticipated. Furthermore, the company predicts that sales increases will continue over the next year at a rate of 4.5%-5.5%. After increasing revenues and earnings (excluding charges related to hurricanes) we were surprised to see the shares slip more than 7%. However, at the moment the stock is hovering right around a significant price threshold and may present a buying opportunity on further weakness. With a historic average Cash Earnings ratio of 7.29x, the stock’s current Cash Earnings ratio of 5.96x should be modestly compelling to value investors. Naturally, we would love to see a better valuation for KR, but to get there one of two things must occur (or both). Either the stock price must decline or KR’s cash earnings must increase.

We currently rate KR shares as Fairly Valued, but should the stock price continue to drop and fundamentals continue to improve, we would become more interested. If there were any further decline into the low $20’s we will very likely rate the stock Undervalued going forward. Kroger is one of the best opportunities in retail and is a potential buy for any investor looking to be defensive in the face of recession.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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