The Kroger Co. (KR), Wal-Mart Stores, Inc. (WMT): How to Play the Grocery Business After Recent Gains

One of the largest grocery store chains in the U.S., The Kroger Co. (NYSE:KR) has ridden the recent market rally particularly well, and is sitting just under its 52-week high as I write this. In fact, over the past year, shares of  The Kroger Co. (NYSE:KR) have gained about 60%, making the overall market rally look like small potatoes.

With increased competition from discount giants with extremely low overheads like Wal-Mart Stores, Inc. (NYSE:WMT), and also from organic and natural food specialty stores like Whole Foods Market, Inc.(NASDAQ:WFM), how should investors play the grocery sector? Is now a good time to take some profits in The Kroger Co. (NYSE:KR), or is there still upside potential here?

A little about Kroger

The Kroger Co. (NYSE:KR) makes the majority (94%) of its money from its supermarkets, of which the company operates over 2,400 of in the United States. The company also operates almost 800 convenience stores under brand names such as Kwik Stop, Tom Thumb, and others, as well as over 300 jewelry stores under such brand names as Littman Jewelers and Barclay Jewelers.

Lately, The Kroger Co. (NYSE:KR)’s growth strategy has been focused on improving its training methods and to provide customers with the best possible shopping experience. The company seems to realize that it cannot be completely price-competitive with companies like Wal-Mart Stores, Inc. (NYSE:WMT), but the goal is to make the experience in its stores so much better that customers don’t mind having to spend a bit more. Having said that, there is some degree of pricing pressure as a result of  Wal-Mart Stores, Inc. (NYSE:WMT)’s low-price strategies, but as long as The Kroger Co. (NYSE:KR) remains competitive, its customer base should remain intact.

Cheap or expensive?

Even after the recent gains, Kroger trades for just 12.4 times last years earnings, and the consensus calls for about 10% annual earnings growth for the next few years. This sounds very good, but first bear in mind that Kroger carries a relatively high debt load of about $5.5 billion (about 30% of its market cap), which does warrant a lower P/E. Historically, Kroger’s average P/E is right around 11 times earnings, so as cheap as it sounds, shares actually trade for a premium right now.

Other ways to play

As mentioned, Kroger faces competition from giant discounters such as Wal-Mart Stores, Inc. (NYSE:WMT), as well as the growing popularity of organic and natural food, the largest seller of which is Whole Foods Market, Inc.(NASDAQ:WFM).