In the past year, the plight of brick and mortar retailers has deteriorated due to the heavy influx of online retailers. However, one of these retailers, Kroger Co. (KR, Financial) has appreciated close to 50 percent in the past 12 months and that is solely because of its rock-solid performance throughout the year. The company has been highly successful in expanding sales and thereby meeting expectations on the bottom line as well. At present, Kroger is trading shy of $60 price tag and therefore, there is strong probability that the price has factored in this high growth. Let us see if the company still represents a good buy.
Q3 results
Before Kroger announced its third quarter earnings, the Street was riding on high expectations and true to their belief, the retailer did not disappoint. Kroger's third quarter profit came in at $0.69 per share, which was 21% above the prior year and higher than the analyst estimate of $0.61 per share. The company highlighted a boost in fuel margins as one key reason for the profit increase. But surprisingly, strong customer traffic helped as well. Sales improved 11% year-over-year to $25 billion and also exceeded expectations. Gross margins after taking into account warehousing and transportation costs came in at 20.9% of sales, a 40 basis point increase versus last year. Net earnings for the quarter rose by 21.1% to $362 million. As a result of share repurchases, growth on a per share basis has been even more impressive, with earnings being up by 28% to $0.73 per share.
While the quarterly results exceeded expectations by a comfortable margin, the outlook for the full year was even more robust. Kroger has announced that it sees full-year adjusted earnings of $3.32 to $3.36 per share. Based on the guidance, fourth quarter adjusted earnings are seen at $0.86 per share. The earnings range given by the company beats analyst estimates of $3.29. Additionally, the sales volume growth is expected to stay consistent in the 4-5% range and the management has the vision of translating this growth to long term EPS growth of 8-11%. Kroger is poised to deliver a strong performance in the coming quarter as well.
The Harris Teeter acquisition helped
One of the primary reasons behind the strong performance by the company was the acquisition of Harris Teeter. The acquisition of Harris Teeter has been quite smooth and Kroger has been able to cut prices, making it a popular move for customers. As CEO Rodney McMullen pointed out, “The Harris Teeter team has done a nice job running their own business, but the other thing is they've been incredibly helpful helping teach all of Kroger some ideas as well. So it's been great so far, and the synergies are moving along as we expected as well.”
However, there is a catch with this particular acquisition. Kroger has leveraged up its balance sheet quite a bit following the Harris Teeter acquisition as well as significant share repurchases. Kroger took on debt to finance the Harris Teeter merger and has not yet realized a full year of Harris Teeter EBITDA. As a result, the company's net total debt to adjusted EBITDA ratio increased to 2.29 as of the close of the third quarter compared to 1.86 during the same period last year. Though the full-year EBITDA of Harris Teeter will be realized in the next full-year, the amount of debt that it has taken for now is considerably high. In order to service this huge debt, Kroger will have to take a bigger chunk from shareholders’ earnings. Also, Kroger will have to put its share buybacks plans to rest in order to build a comfortable cash position.
Takeaway
As I mentioned above, Kroger’s management expects full-year EPS to come in the range of $3.32 to $3.36 per share and based on that, the current earnings multiple works out to 19-20. Though the P/E multiple is in alignment with its peers like Walmart (WMT) and much lower than other strong-performing retailer Costco (COST), Kroger’s leverage Balance Sheet conveys it to be a risky proposition. Therefore, Kroger is currently not an ideal pick for defensive investors as the market has already factored in all the good news. However, for an investor who has a better risk appetite to tolerate short-term volatility, this stock represents a potential gain-maker.
