Kroger (KR, Financial), the second-largest grocer in the U.S., is also one of the worst-performing retailers in the U.S. stock market. Kroger has declined by more than 40% in the last year, and it might continue the downward trend until it shows marked improvement in comparable store sales. But the sharp decline in stock price has pushed Kroger’s yield to nearly 2.5%, making it an extremely attractive investment for dividend investors. The question is: How safe is Kroger for investors who are ready to hold the company for the long term?
The reason why Kroger has lost so much value in the last year is because the market expects competition to wipe out not just sales growth but also margins in the grocery business. The No. 1 grocer in the U.S., Walmart (WMT, Financial), is already growing and taking away market share from other grocers. Amazon (AMZN, Financial), which had a marginal presence in the U.S. grocery market, bought Whole Foods for $13.7 billion and immediately announced that it would slash prices by up to 43%.
Though the Amazon/Whole Foods combo holds less than 1.5% of the U.S. grocery market, it is easy to conclude that Amazon will keep slashing prices, which will leave other grocers with two choices: follow suit or go under. The price war will clearly wipe out any bottom-line profits, and the competition will require continous investments, further straining overall margins.
All these companies have billions of dollars in cash flow and have the strength to compete for many more years to come, and the market understands that the grocery war will take many more years to clearly show us the winners and losers. For now, it has chosen to punish companies that are not able to show sales growth. Kroger’s comparable store sales declined during the first quarter after growing for 13 years.
During the second quarter, Kroger returned to the positive side of comparable store sales, posting 0.7% growth. But the problem is that Kroger is not expecting this to improve in the second half of the year, and it expects comparable store sales – excluding fuel – to grow in the 0.5% to 1% range. This will definitely put a lot of downward pressure on the stock, and if you are planning to buy Kroger you will get plenty of opportunities in the next six months.
Kroger’s balance sheet is not that strong, but it isn’t in bad shape, either. At the end of the second quarter of the current fiscal, Kroger was sitting on top of $13.1 billion in long-term debt against $819 million cash on hand. The $138 million interest the company paid during the quarter looks manageable, as its operating profit was $678 million. Kroger paid $221 million in dividends during the quarter, which was 32% of its operating profit.
Kroger has enough strength to keep paying its dividends as it fights to keep improving its sales numbers. Amazon will take many more years to improve its market share; Whole Foods, with its 400-plus stores, is still way too small in the $800 billion grocery market. It will give enough time for Kroger to consolidate its position in the 35 states the company operates in. It won’t be a cakewalk, but there are enough factors, such as store presence, a long history of sales growth and high penetration in certain states that can help Kroger stay in the U.S. grocery game.
Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.
