Post-earnings release in mid-June of its first quarter 2017, Kroger (KR, Financial) shares fell about 26%. In addition to investors not being contented with the lowered guidance set by the retailer, the initial share price decline was exacerbated when Amazon (AMZN, Financial) announced its intentions to purchase Whole Foods (WFM, Financial) the following day.
Nonetheless, the $20 billion Ohio-based retailer delivered 4.9% revenue growth to $36.3 billion and a disappointing 56.5% fall in profits to $303 million having represented 0.8% margin compared to 2% in the same period last year.
Kroger recorded a 6.8% increase in costs to $2.3 billion thus leading to lower profits in the recent quarter.
In addition, Kroger lowered its 2017 GAAP (generally accepted accounting principles) earnings per share (EPS) to $1.74 to $1.79. This would indicate a 14.3% decrease with midpoint comparison to previous year’s figures.
Kroger's adjusted EPS range is now 9.2% lower at $2.00 to $2.05 for the fiscal year. The previous adjusted net earnings guidance range was $2.21 to $2.25 per diluted share.
"We remain focused on our strategy. This will make a difference for our customers and create value for our shareholders. We are running the business with an eye toward where the customer is going. Customers tell us they want to connect with us in multiple ways with the help of friendly associates to easily provide meals to their families at prices that enable them to stretch their budgets. We are committed to providing that experience, and we will not lose on price.
"We are driving our strategy of lowering costs to reinvest in ways that provide the right value to our customers. We're pleased that identical supermarket sales in the last nine weeks of the first quarter were positive, and that has continued in the second quarter to date."Â – Chairman and CEO Rodney McMullen
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Valuations
Kroger is undervalued in terms of a trailing price-earnings (P/E) at 13.4 times compared to its peer median of 20.7 times (GuruFocus). The retailer also had a price-book (P/B) ratio of 3.4 times vs. the industry’s 1.9 times and a price-sales (P/S) ratio 0.18 times vs. the industry’s 0.49 times.
The company also had a trailing dividend yield of 2.15% with 22% payout ratio.
Average 2017 revenue expectations indicated a forward P/S ratio of 0.18 times and midpoint of company-expected EPS indicated 12.6 times.
Total returns
Kroger provided 34.7% total losses to its shareholders so far this year compared to Standard & Poor's 500 index’s 9.7% (Morningstar). Nonetheless, the retailer outperformed the broader index by a little over one percentage point at 16.2% in the past five years.
Kroger
According to filings, the Kroger Co. was founded in 1883 and incorporated in 1902. As of Jan. 28 Kroger was one of the largest retailers in the world based on annual sales. The company also manufactures and processes some of the food for sale in its supermarkets.
Kroger operates supermarkets, multidepartment stores, jewelry stores and convenience stores throughout the U.S.
The company aggregates its operating divisions into one reportable segment due to the operating divisions having similar economic characteristics with similar long-term financial performance.
Nonetheless, Kroger provided different revenue generators of its business. In the recent fiscal year, 52% ($60.2 billion) of Kroger’s sales were generated in nonperishable, 24% from perishable items, 12% from fuel and 9% in pharmacy.
Sales and profits
In the past three fiscal years, Kroger had revenue and profit growth averages of 5.5% and 9.1% (Morningstar). The retailer also had an average profit margin average of 1.72%.
Cash, debt and book value
As of May, Kroger had $335 million in cash and $13.4 billion in debt with debt-equity ratio of 2.2 times vs. 1.9 times the same period last year. As observed, overall debt increased by $1.1 billion while shareholder equity has fallen $313 million.
Of Kroger’s $35.8 billion assets 11.7%Â were in goodwill and intangibles. The retailer also recorded 4.9% decline in book value to $6.1 billion (1).
Cash flow
Kroger’s year-to-date cash flow from operations rose by 11% to $2.3 billion. As observed, the retailer had increased cash flow in the following: receivables, inventories, prepaid and other current assets, and trade accounts payable.
Capital expenditures were $817 million leaving the company with $1.49 billion in free cash flow compared to $989 million in the same period last year. In addition, the company allocated 58% of its free cash flow in dividend payouts and buybacks, net any issuances.
On average, Kroger had a free cash flow payout ratio of 183% in the past three fiscal years.
Conclusion
According to Kroger, the company accounts for its last in, first out (LIFO) charge during the first three quarters of each fiscal year and the recognition of LIFO expense is affected primarily by estimated year-end changes in product costs. This line item, including advertising and merchandise costs, rose by 6% to $28.2 billion on a year-over-year basis.
Also observed is how sales, general and administrative costs have increased by 10% on a year over basis –Â fairly consistent with Kroger’s first quarter operations last year. The increase in expenses led to significantly lower profits in the recent quarter.
Meanwhile, Kroger exhibited a leveraged balance sheet accompanied by generous payouts to its shareholders in recent years.
Twenty-two analysts have an average price target of $32.5 a share – 45.8% higher than the share price of $22.3 per share (at the time of writing). Applying average revenue growth and P/S multiple averages in the past three fiscal years followed by a 30% margin indicated a value of $38.5 billion or $29.5 per share.
Ignoring the possible threat from the recent acquisition mentioned above and the company’s leveraged balance sheet, Kroger is a buy with a $30 per share target price.
Notes
- Me: It was not determined how much of Kroger’s revenue came from online sales based on recent 8-K and 10-K filings.
Disclosure: I am long Kroger shares.
