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The Kroger Co. spans many states with store formats that include grocery and multi-department stores, convenience stores and mall jewelry stores. KR operates under nearly two dozen banners.
- Supermarkets
- Price-Impact Warehouse Stores
- Multi-Department Stores
- Marketplace Stores
- Convenience Stores
- Jewelry Stores
- Financial Services
The recession took its toll on Kroger last year when earnings from continuing operations dropped from FY 2008’s all-time high of $1.90 /share to $1.71 /share despite higher sales. FY 2009 (ended Jan. 31, 2010) was still the second best year ever for EPS and Q4 came in ahead of scaled back analyst estimates.
The nature of the grocery business makes it more predictable than most. Value Line rates Kroger’s ‘stock price stability’ and ‘earnings predictability’ at the 100th and 80th percentiles respectively (with 100th being best). Zacks now sees FY 2010 and FY 2011 coming in at $1.76 and $1.99. Standard and Poors is looking for a similar $1.79 and $2.00 in EPS.
That puts KR’s multiple at about 12x this year’s and< 10.7x 2011’s expected earnings. The last time the P/E on these shares averaged as low as those was in 2002. Buyers at the bottom in 2002 watched their shares move from $11 to $19.70 over the next 12 months.
Here are KR’s per share numbers (excluding non-recurring items) as reported by Value Line:
FY* | Sales | C/F | EPS | Div. | B/V | Avg. P/E |
2002 | 68.28 | 3.15 | 1.65 | Nil | 5.08 | 11.3x |
2003 | 72.40 | 2.80 | 1.16 | Nil | 5.40 | 14.3x |
2004 | 77.52 | 2.77 | 1.03 | Nil | 4.86 | 16.3x |
2005 | 83.75 | 3.07 | 1.31 | Nil | 6.07 | 14.0x |
2006 | 93.77 | 3.39 | 1.54 | 0.26 | 6.98 | 14.1x |
2007 | 105.94 | 3.83 | 1.69 | 0.30 | 7.41 | 16.4X |
2008 | 117.10 | 4.15 | 1.90 | 0.36 | 7.98 | 14.1X |
2009 | 117.99 | 4.02 | 1.71 | 0.365 | 7.63 | 13.5X |
* FY’s end Jan. 31st of the following year | ||||||
Kroger shares are low-volatility (Beta = 0.6) and conservative. Value Line rates them ‘above average‘ for safety and lists their financial strength as B++. Even in the worst of the 2008-2009 market crash KR never went below $19.45 /share. The absolute lows in 2007 and 2008 were above today’s asking price at $22.90 and $22.30.
With a recovering economy and higher estimates for both this FY and next I see very little risk in these shares from today’s price of $21.20. The dividend was raised in Q4 2009 and the current yield is a well-covered 1.8%.
What are Kroger shares worth? Even 14x projected earnings would bring KR back to $24.64 within a year and about $27.85 within two years. Outright buyers of the shares could have a goal of 12-month total return of 15% - 20%.
Kroger is a decent quality, medium yield stock with well-defined prospects for a double digit return on a low-risk holding.
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If you’re comfortable with option trading you might want to consider writing (selling) these LEAP puts:
Expiration / Strike | Put Premium /Share | Net Cost (If Put) | Margin of Safety* |
Oct. 2010 / $21 | $1.45 | $19.55 | 7.7% |
Oct. 2010 / $22 | $2.00 | $20.00 | 5.6% |
Jan. 2011 / $22.50 | $2.60 | $19.90 | 6.1% |
Jan. 2012 / $20 | $2.15 | $17.85 | 15.8% |
Jan. 2012 / $25 | $5.10 | $19.90 | 6.1% |
* Margin of Safety = % that break-even point is below today’s quote | |||
If you sell any of these options your worst case scenario would have you buying the shares at the indicated ‘net cost’ – all prices well below today’s already cheap price.
Your maximum profit would be to collect and keep the premium(s) received without ever being ‘put’ the shares.
You would need to maintain a margin requirement in either cash or marginable securities in your ‘options approved’ margin-type account for the duration of the trade.
Writing the 2012 expiration date puts would allow you the most ‘float’ on the option premiums received while deferring your taxable gains (if the puts expire worthless at expiration) until you file your 2012 Schedule D in the spring of 2013.
If the options you write go unexercised you’ll have made nice profits without ever having bought the shares. If the puts do get exercised you’ll end up owning attractive KR shares at a price from 5.6% - 15.8% below the asking price at the trade’s inception date.
Dr. Paul Price
www.BeatingBuffett.com
Disclosure: Author is long KR shares and short KR options.
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Paul, you write a lot of these articles marrying short option positions with stock ownership. I'm curious, what amount of your portfolio is tied up, on average, with margin requirements? And at what level of implied volatility does it just not make sense to continue this strategy? I have been short KR puts for many months now, and continue to be, but in general, it seems like the easy money is already made.