Kroger (KR, Financial) is one of the largest with 2,620 supermarkets, 786 convenience stores, 326 fine jewelry stores, 1,360 supermarket fuel centers and 37 food processing plants in the U.S. Kroger has also been a strong value creator in 2015 with the stock providing returns of 26.5% year to date, and it remains an attractive investment for 2016.
From a valuation perspective, Kroger currently trades at 20.2 times TTM PE. Further, the stock is trading at 18.2 times FY17 (January 2017) PE, and these don't seem to be expensive valuations. With the U.S. manufacturing sector already in contraction, the consumption sector is the key driving force, and Kroger is well positioned to benefit from that in the coming year.
An important point to mention here is that Kroger had earlier provided 2015 EPS guidance of $1.92 to $1.98 per share. However, that was revised in 3Q15 to $2.02 to $2.04 per share. With the new guidance range exceeding the company’s long-term earnings growth rate expectation of 8% to 11%, the company’s growth trajectory is robust and FY16 can potentially be another strong year.
The next factor that is likely to trigger stock upside for Kroger is the dividend growth potential in 2016 and beyond. Kroger currently offers dividend payout of 42 cents per share, but the management has indicated that strong earnings growth will translate into a dividend increase, and I see strong dividend growth coming in FY16.
From a growth perspective, the best indicator for Kroger is the company’s identical supermarket sales. For the third quarter of 2015, Kroger reported 5.4% identical supermarket sales growth. Further, for FY15, the company expects identical supermarket sales growth, excluding fuel, of 4.0% to 4.5%, and this implies overall identical supermarket sales growth of 5.0% to 5.25% for 2015.
There are two factors driving identical sales growth – very strong tonnage growth and increase in number of households shopping with Kroger.
The latter is an indication of the brand pull that has been created through growing connection with customers. This factor will continue to ensure that identical supermarket sales remain robust in FY16. This, in turn, will continue to drive EPS growth.
Within the broad business, Kroger has reported double-digit identical sales growth in the company’s natural foods department. In this segment, Kroger seems to be moving ahead of competitors such as Whole Foods Market (WFM, Financial) and Natural Grocers by Vitamin Cottage (NGVC, Financial).
From a financial perspective, Kroger has $11.1 billion in debt (including $2.3 billion in short-term debt), but I don’t see that as a concern. The company’s annualized debt servicing cost is around $530 million, and the annualized EBITDA is nearly $5.6 billion. This translates into EBITDA interest coverage of 10.6.
Further, it is worth noting that Kroger generated $1.2 billion in free cash flow for the first nine months of 2015 with the company paying $283 million in dividends for the same period. With a strong free cash flow buffer, Kroger is well positioned to increase dividends in the coming year in addition to continued share repurchase that provides incremental value creation.
Kroger is an attractive investment for 2016 even after the stock has provided strong returns in 2015. With the company’s identical store sales showing robust growth, the business fundamentals are strong and attracting customers. Investors can consider exposure to the stock at current levels and on any potential correction.
Disclosure: No positions in the stock
