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General overview
hooks (NYSE:cf.) has underperformed this year, decreasing by over 3% for the year. However, I believe this creates an excellent entry opportunity to acquire shares of a solid company. Kroger has a great business model to match consumer spending trends. They also have an excellent track record of dividend growth, while demonstrating growth even during economic uncertainty. The initial dividend yield stands at 2.6%, which is above its five-year average.
Kroger Co is a US-based food and drug retailer. They run different types of stores, including combination grocery and drug stores, multi-department stores, and price-influenced warehouses. In their food and drug combination stores, they offer a variety of products such as organic food, pharmaceuticals and general merchandise. In short, KR can be compared to Target (TGT) or Walmart (WMT). We can you actually see that Kroger has fared better compared to TGT and WMT while also outperforming the S&P 500 (SPY) during the last 3 years.
Consumer spending
I have often perceived Kroger (cf.) as an undervalued player in the market due to its average dividend yield of 2% and limited presence in the Northeast. In my hometown, it’s likely that most people haven’t even come across a Kroger. Despite this, Kroger consistently exceeds $100 billion in annual sales, even without a strong base in densely populated regions like New York, New Jersey and Florida, hinting at untapped growth potential.
Kroger’s lying and the continued expansion of its private label business accounts for about 30% of its total revenue. Operating 35 food manufacturing facilities, Kroger produces a significant portion of its private label products in-house.
According to knowledge, as costs rise, 54%% of consumers are returning to store brand/private label items while shopping. Given that one-third of Kroger’s revenue is derived from private label items, the company enjoys increased control and can capitalize on higher profit margins. Looking ahead, the continued increase in grocery costs due to inflation positions Kroger for steady earnings growth.
Examining historical trends, Kroger has not only weathered past recessions with growing revenue, but has also shown consistent growth since its inception despite small declines in net income during the economic downturn.
finances
Kroger’s second quarter earnings ratio reveals strategic challenges and successes. Like-for-like sales without fuel rose 1.0%, showing an underlying increase of 2.6%. However, the company reported an operating loss of ($479) million, with an EPS of ($0.25). In particular, a $1.4 billion charge related to a statewide opioid settlement framework significantly impacted earnings.
Kroger Profits Deck
On a positive note, adjusted FIFO Operating Profit came in at $989 million, resulting in adjusted EPS of $0.96. Kroger focused on executing its go-to-market strategy, resulting in a 12% increase in digital sales. Despite a drop in the company’s total sales from $34.6 billion to $33.9 billion compared to the same period last year, sales rose 1.1%. Gross margin was 21.8%, with the FIFO gross margin rate increasing 35%.
E-commerce has suddenly become a success story for Kroger, with projections indicating that it will be 20% of the US grocery market by 2026. Over the past few years, Kroger has seen steady growth in its online sales, starting in 2017 and culminating in an impressive $12.8 billion in 2021.
statesman
While traditional store revenue remains a cornerstone for Kroger, the upward trajectory of e-commerce sales suggests a key role in the company’s future growth. Projected to reach an estimated annual net sales of $23.8 billion by 2027, the e-commerce segment is poised to play a crucial and expanding role in Kroger’s overall business strategy.
Albertsons Union (ACI)
Kroger has a strong track record of stock buybacks, although they temporarily halted this strategy pending a potential merger with Albertsons Companies (ACI). The success of the merger could address the previously mentioned location challenges and serve as an important catalyst for growth, significantly improving their scale and infrastructure.
The proposed merger with Albertsons has the potential to create a formidable powerhouse by leveraging the strengths of both companies. The combined entity would display an impressive scale, comprising approximately 5,000 stores and employing over 700,000 individuals.
Kroger Profits Deck
While there is uncertainty about the completion of the merger, if it doesn’t go through, Kroger remains well positioned to flourish. In such a scenario, I foresee the company resuming its share buyback initiatives, further contributing to its financial strength and stability.
Dividend
From the last one DECLARING dividend of $0.29/share, the dividend yield stands at just over 2.6%. Kroger has consistently demonstrated financial stability, boasting strong cash flows, strong liquidity and manageable debt levels. KR has a commendable history of increasing dividends for 16 consecutive years, with an average 5-year growth rate which exceeds inflation at 15.7%.
Over the years, Kroger’s revenue has grown nearly 50% since 2013, accompanied by a corresponding increase in free cash flow. Importantly, the company currently carries lower levels of debt than before the start of the 2020 pandemic. The company maintains a very conservative payout ratio of less than 30%, supported by its strong cash flow. Based on these factors, I keep increasing the dividend to continue in the future.
Something that bolsters the cash flow available to support a growing dividend are the cost-saving initiatives KR is prioritizing. CFO statements confirmed this cost-saving initiative as well as planned future dividend increases:
Our cost-saving initiatives are focused on simplification and using technology to improve the associate experience without impacting the customer. We remain on track to deliver our sixth consecutive year of $1 billion in cost savings.
Kroger continues to generate strong free cash flow through solid operating results and working capital improvements. At the end of the second quarter, Kroger’s total net debt to adjusted EBITDA ratio was a record high of 1.31. This compares to our total net debt to adjusted EBITDA target range of 2.3 to 2.5. The Company expects to continue paying its quarterly dividends and expects this to increase over time, subject to Board approval. – Gary Millerchip, SVP and Chief Financial Officer
ASSESSMENT
With a current price-to-earnings (P/E) ratio of 13.2, Kroger is at a discount when compared to the sector average of 18.95. However, for further insight, we can use a discounted cash flow model to determine an estimated fair value. Since the most recent year-over-year revenue growth was only 2.7%, we’ll use this as an input to our estimate. Combining a conservative estimated annualized growth of 2.7% with an EPS (earnings per share) multiple of 4.5x, we conclude that KR is slightly undervalued.
Money chimpanzee
Using this data, we conclude that a fair value for KR stock is about $55.68/share. This would represent a 30% price increase from current levels. Wall St. price targets range from $42 per share to $65 per share, with an average price target of $51.50 per share. Our estimates fall within this range, and as inflation cools and consumer spending on groceries continues to increase, we expect annual revenue growth to pick up as well.
Despite the relatively low trailing yield and average earnings growth, I’ve bought the stock because I believe Kroger’s growth potential is not fully reflected in its valuation relative to competitors. This is partly attributed to the company’s limited presence in densely populated areas.
Takeaway
hooks (cf.) represents a compelling investment opportunity despite the 3% decline this year. The company’s impressive business model aligns with consumer spending trends, and its history of dividend growth, with a current yield of 2.6%, indicates financial stability and growth potential.
Kroger’s resilience during economic uncertainties and its continued revenue growth, even in the absence of strong ground in certain regions, underscore its untapped growth potential. The company’s success in e-commerce, which is expected to account for 20% of the US grocery market by 2026, positions it for steady growth.
Additionally, Kroger’s potential merger with Albertsons (ACI) and history of share buybacks further contribute to its growth prospects. Valuation analysis, including a fair value estimate of $55.68 per share and Wall Street price targets, supports the notion that Kroger is undervalued.
