Why You Should Invest In Kroger

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Sep 05, 2014
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In this article, let's take a look at The Kroger Co. (KR, Financial), a $25.35 billion market cap company, which is a supermarket operator with over 2,650 stores in 34 states and also operates convenience stores, jewelry stores, supermarket fuel centers and food-processing plants.

Fierce competition

The company faces strong competition from rivals that are expanding their food offerings. Competitors such as Wal-Mart (WMT, Financial), Target (TGT, Financial), and Costco (COST, Financial) use food as a loss leader in order to drive traffic into stores.

Obviously this is extremely difficult to imitate for traditional grocers because they generate profits from food sales.

With more than 2,600 store locations and about $100 billion in sales, the company has developed a scale that allows it to negotiate volume discounts and better fixed costs to compete with its peers.

Private products

The company offers about 13,000 private label products that are sold in three tiers. The majority of the private labels are Kroger, Ralphs, King Soopers, which are designed to be equal to or better than the national brand. Further, these private-label products have higher margins than others, as well as controlling the supply chain.

Customer-first strategy

This strategy consists on improving employee communications and training. Making data-analysis, they personalize stores trying to boost customer loyalty.

We think that having multiple store formats, store cleanliness and security, reducing checkout wait times and having lots of price discounts make customers' shopping experiences better.

Gasoline offerings

Half of Kroger’s locations have gasoline offerings, and this allows the firm to remain competitive relative to large multinationals.

Harris Teeter Supermarkets

Kroger has made various acquisitions since 2006, but this one is nearly three times as large as all the previous acquisitions.

In Jan. 2014, the supermarket purchased Harris Teeter Supermarkets (HTSI, Financial), an operator of 227 Mid-Atlantic retail stores, for $2.6 billion.

With the deal, synergies could be achieved due to important cost savings ($40 million to $50 million over the next 3 to 5 years). Further, it also complements Kroger to better its positions in North and South Carolina.

Revenues, margins and profitability

Looking at profitability, revenue growth by 9.88% led earnings per share increased in the most recent quarter compared to the same quarter a year ago ($0.98 vs $0.91).

During the past fiscal year, the company increased its bottom line. It earned $2.90 versus $2.77 in the prior year. This year, Wall Street expects an improvement in earnings ($3.28 versus $2.90).

Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.

Ticker Company ROE (%)
KR Kroger 28.21
SWY Safeway 60.27
PTRY Pantry Inc -0.93
DEG Delhaize Group SA 3.53
WFM Whole Foods Market Inc 14.21
 Industry Median 10.58

The company has a current ROE of 28.21% which is higher than the industry median. In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. For investors looking at higher levels, Safeway (SWY, Financial) could be the option. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.

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Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 17.3x, trading at a discount compared to an average of 21.2x for the industry. To use another metric, its price-to-book ratio of 5.5x indicates a premium versus the industry average of 2.07x while the price-to-sales ratio of 0.3x is below the industry average of 0.49x.

As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $25.741, which represents a 20.8% compound annual growth rate (CAGR).

03May20171401291493838089.png

Final comment

As outlined in the article, the firm has an important merchandising strategy, to compete with rivals that have their own strategies. Further, acquisitions like the one of Harris Teeter which operates stores mostly outside of Kroger's markets help it to reach new regions. Moreover, the Kroger brand is designed to deliver products with good quality at good prices is a growth driver for the years to come.

The PE relative valuation and the return on equity that significantly exceeds the industry average and make me feel bullish on this stock.

Hedge fund guru like Ken Fisher (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014, as well as RS Investment Management (Trades, Portfolio) and Pioneer Investments (Trades, Portfolio).

Disclosure: Omar Venerio holds no position in any stocks mentioned