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Food For Thought – The Kroger Company

March 24, 2010 | About:
Kroger is America’s largest grocery store chain (by sales) and ranks #1 or #2 in 38 of its 44 major markets. Headquartered in Cincinnati, Ohio, Kroger (NYSE:KR - $21.20) posted record fiscal 2009 sales of $76.7 billion.


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.


******************************************************************************

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.

About the author:

Dr. Paul Price
http://www.RealMoneyPro.com
http://www.MarketShadows.com
http://www.TalkMarkets.com

Visit Dr. Paul Price's Website


Rating: 3.0/5 (6 votes)

Comments

fcharlie
Fcharlie - 4 years ago
Kroger is probably the closest I've ever seen to a sure thing in a long time. I can't see any possibility of losing money with what you've presented.

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.

Dr. Paul Price
Dr. Paul Price premium member - 4 years ago


FCharlie,

If you think Kroger will be higher in the future there is still money to be made by writing puts.

I sell lots of puts on a regular basis while always keeping a reasonable cash reserve to allow for the occasional exercise. Most of the margin requirements are met with stocks I'm holding already in my margin-type account.

When interest rates were not near zero I used to get great income just from the float on the money I generated from selling both calls and puts. The premiums still provide great cash inflow while locking in shares at lower than market prices or getting paid "not to buy stock".

fcharlie
Fcharlie - 4 years ago
Paul,

I do think Kroger will be higher, certainly not lower in the future, therefore I still remain short KR puts 2011 and 2012.

I guess what I'm asking is, and perhaps I worded it incorrectly before... What level of equity do you maintain in your account? It's just that you appear, based on your writings, to be short many options on many stocks, and I assume based on the above comment, the proceeds are used to purchase additional shares. This has been a fantastic strategy as the VIX declines from 79 to 17...Were implied volatility to ramp up, how does your strategy change? Did you apply this same strategy before and during the crash or is there a point where you flip it and begin to sell mostly call premium?

Dr. Paul Price
Dr. Paul Price premium member - 4 years ago
I sell both calls and puts whenever I think the premiums look attractive.

Often I sell both calls and puts on the same underlying shares for the same expiration date. That sets up a wide band of profitability if the shares go up, stay level or even if they decline slightly.

The startegy works well in any market environment except a huge bear such as 2008 through early 2009. That was a very bad period for me.

That said, my account was up over 140% for all of 2009 showing that consistent usage of the techniques will work as long as you don't bail out (in fear) at the bottom.

You can see more than 100 of my buy/write combinations from the period June 2008 - August 2009 and their final results by going to www.BeatingBuffett.com . Every trade [good or bad] through August of 2009 is followed up (in the comments section for that article) as to the results through January 15, 2010.

***********************************************************************************

In my IRA I buy good stocks and write covered calls regularly. My IRA was just over $301,901 as of December 31, 1999 and is now back above $1,000,000 and near its spring of 2007 highs again.

I feel very proud of this result with an unlevered account during 10 years of putrid stock market results for the DJIA and S&P 500.


Dr. Paul Price

www.BeatingBuffett.com

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