Results for the Kroger Co. (KR, Financial) have been excellent year to date. The catalyst for this growth has been the ongoing Covid-19 pandemic, which has forced consumers to eat more meals at home. The pandemic doesn't appear to be lightening up as the number of cases continues to grow nationwide. More states have been imposing restrictions on indoor dining, if they even allow for people to eat inside of restaurants.
That said, shares of Kroger have lost more than 15% over the last three months while the S&P 500 is 6% higher.
On the heels of first and second-quarter results where earnings per share grew a combined 68% and revenue improved 10%, Kroger's third-quarter was also quite strong. Is this, plus the decline in share price, enough to buy shares of the company?
Quarterly highlights and valuation analysis
Kroger reported third-quarter earnings results on Dec. 3. The grocery store chain's adjusted earnings per share of 71 cents was an increase of 24 cents, or 51%, from the prior year. This was also 5 cents ahead of what Wall Street analysts had expected. Revenue grew 6.3% to $29.7 billion, but was $242 million short of estimates.
Comparable sales excluding fuel were higher by 10.9% compared to consensus estimates of 9.3%. Outside of fuel, which saw a 13% decline in gallons, growth was broad-based. Kroger has seen real success with its own brands. For example, brand growth was 8.6% in the quarter, but Private Selection grew 17% while Simple Truth was 15% higher. Digital sales more than doubled, adding 4.6% to comparable sales.
Kroger has also focused heavily on bringing new products to market, including launching 250 in the third quarter alone. This was the most ever for a single quarter. Included in this product launch was an expansion of the Simple Truth plant-based foods, which helped drive the double-digit growth for the brand in the quarter.
The company also leveraged its data to drive higher sales. Leadership states that its efforts to personalized email offers are opened at a much higher rate than the industry average. The company says that 95% of customer interactions with the Kroger website and app stem from personalized offers, which has led to a higher number of sales. This is evident by the growth seen in digital sales.
Kroger has shifted to delivery and curbside pickup seamlessly during the pandemic. The company has more than 2,450 delivery locations and more than 2,200 pickup locations. Leadership says that pickup and delivery options cover 98% of the company's customer base.
Kroger continues to be a very shareholder-friendly company. Nearly $304 million of shares were repurchase during the quarter, bringing the year-to-date repurchase total to $989 million. This follows Kroger's 12.5% dividend increase that was announced in June, giving the company 14 consecutive years of dividend growth.
Following third-quarter results, Kroger raised its expectations for the full year as comparable sales excluding fuel are seen as growing around 14% with adjusted earnings per share growth of 50% to 53%. Using the previous year's results, this translate to adjusted earnings of $3.32 per share at the midpoint.
Using the current share price of $30.58 and expected earnings per share for the year, Kroger trades with a forward price-earnings ratio of 9.2. According to Value Line, shares have had an average price-earnings ratio of 13.3 since 2010. Using the stock's 10-year average price-earnings ratio has Kroger looking undervalued.
Kroger also looks undervalued using the stock's current dividend yield versus its historical average. Kroger pays an annualized dividend of 72 cents per share, which results in a yield of 2.4% today. This compares favorably to the stock's 10-year average yield of 1.8%. Were shares to average the current yield for the year, then it would tie last year's average yield for highest since the company began paying a dividend in 2006. The stock would have to reach $40 to trade with its long-term average yield.
On the other hand, GuruFocus sees shares as fairly valued.
Kroger has a GF Value of $31.31, which equates to a price-to-GF Value of 0.98. This earns Kroger a rating of fairly valued from GuruFocus. Shares are only about 2% away from their GF Value.
However, taking into account the stock's historical price-earnings ratio and slower growth pre-pandemic, I have a target valuation range of 10 to 12 times earnings for shares of Kroger. Applying expected earnings per share to this range gives a price target range of $33 to $40, which would represent a 7.9% to 31% gain from the current share price.
Add in the dividend yield and shareholders could be looking at total returns of 10% to almost 33% if Kroger were to trade closer to its historical average valuation.
Final thoughts
Kroger continues to be the beneficiary of Covid-19-related restaurant closures. The company is also bringing new products to market that are having an immediate effect on results. The shift to curbside pickup and delivery has been handled very well as nearly all customers are able to get their orders filled.
The stock offers a higher-than-usual yield while trading below its long-term average valuation. Kroger isn't too far off of its GF Value, but I believe the stock has the potential for double-digit total returns as stores should continue to see a tailwind from the ongoing pandemic. As such, Kroger looks like a buy today.
Disclosure: The author has no position in any stocks mentioned in this article.
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