Kroger is considered one of the oldest and largest in the U.S. based on annual sales. The company was founded in 1883 and incorporated in 1902. The business is to manufacture and process some of the food for sale in its supermarkets. For fiscal year 2011, it had 2,460 supermarkets and multi-department stores, 1,014 of which had fuel centers. In addition, it operated through subsidiaries 784 convenience stores, of which 87 were franchised, and 361 have jewellery stores.
Kroger just recently announced second quarter 2011 results for shareholders. In the conference call, CEO David Dillon has mentioned the strong performance of the quarter. Identical supermarket sales increased 5.3%, excluding fuel. And this quarter sales marked the 31st consecutive quarter of positive identical sales growth. Further, he has explained the five external factors that are shaping Kroger’s operating environment this year.
The first is the depressed economy, which led consumers and households to restrain their budget while “increasing consumer anxiety.” Kroger was affected, as most discretionary spending is based on how people feel about the overall economy.
Second is the rise in food and fuel prices. However, Kroger keeps managing to reduce the overall pricing of items in its stores.
Third, the competitive retail environment is rational and Kroger price check has show that most competitors are passing higher costs to consumers. Nevertheless, there are some exceptions to this. During the quarter, retails did not rise at the same pace as costs because of the shortages in product due to the late growing season.
Forth, the increase in pension and healthcare costs for this year remains a significant challenge.
And the last is that fuel is an important part of the business but has a high level of variability. Retail fuel operations went higher than EPS compared to last year.
As far as higher food costs, Kroger executive teams have been doing everything they can to minimize the impact. They have estimated that the team has lowered customer’s shopping bill by $2.1 billion per year. For the quarter, Kroger’s loyal household grew at a faster rate than total household growth, with positive identical sales for both total household and loyal household, and stronger growth in the latter. The higher identical sales for this quarter was driven mainly by the mixture of more households and higher price per unit.
On the long-term strategy of Kroger, executives are focusing on generating cash flows as well as allocating those cash flows for shareholders’ benefit. The company is using cash flows for capital expenditures, repurchasing shares, paying dividends and maintaining the current debt rating. Kroger has invested $258.6 million to repurchase 10.6 million shares at the average price of $24.3 per share during the quarter. Since the end of the quarter, it has purchased 4.5 million shares at the average of $22.87 per share for a total of $103.5 million. The executives expect to use the full billion dollars in the share repurchase plan during fiscal 2011.
The expectation with long-term growth model is 6-8% EPS over rolling 3-5 year horizon, including dividend yield of 1.5% to 2% to total shareholder return rate into 8-10% range.
Looking back at the past of the free cash flow that Kroger is generating, we can see the last 10 years of positive cash flow with gradually growing but fluctuating
At the end of fiscal 2011, the FCF stays at US$2.28, whereas the stock price stays at $22, so the P/FCF is around 10 times.
However, the setback is the high leverage that Kroger has experienced over time. The high leverage is due to two reasons; the first is because Kroger has taken long-term debt equivalent around 30% of total assets in the company, at the book value of $6.7 billion, second is the share buybacks that the company has executed with the total value of $7.2 billion.
If Kroger keeps the performance, of returning on shareholders equity of 23-24% like it did in the number of times over the last 10 years (although got some negative and low year), keep the asset turnover increasing over time, and fulfil the shares repurchase program with the current price, the old retailers can be considered the stocks to hold for the long-term with this current valuation of 10 times multiples on current free cash flows, along with other stocks in diversified basket.
This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.