The Kroger Co. (NYSE:KR) has been on a rally recently for several reasons: it continues to beat analysts’ expectations, it’s growing at the high range of management forecasts, it is increasing same store sales, it has a strong and growing pharmacy business, it is cheap when compared to other retailers, and The Kroger Co. (NYSE:KR) continues to reward shareholders with a growing dividend. But has it rallied too much, or is there still room for the stock to grow?
Grocery store chain Kroger beat estimates again, beating on both the top and bottom line. They posted revenues of $24.2 billion (versus $24.01 billion expected) and EPS of 77 cents (versus 70 cents expected). Kroger grew its revenues by 13%, and went from a large loss last year due to pension costs to posting a net gain of $461.50 million. The Kroger Co. (NYSE:KR) is well on its way to maintaining its 8%-12% EPS growth rate (I would guide towards 11%-12% EPS growth) and 10% revenue growth rate.
Management is guiding that identical supermarket sales (excluding fuel) will grow by 2.5% – 3.5% in 2013. In Kroger’s latest quarter they saw 3% identical supermarket sales growth, versus 0.8% for rival Safeway Inc. (NYSE:SWY) and 1% for Wal-Mart Stores, Inc. (NYSE:WMT).
Two quarters ago I recommended buying shares of Kroger before earnings. Since then, Kroger has gone from $22 a share to $31 a share today. Over the past 9 quarters The Kroger Co. (NYSE:KR) has beaten 9 out of 9 earnings estimates, with an average beat of just over 5%. This is one reason to be bullish on Kroger, because they can continuously outperform estimates, which means there could be hidden value in the stock that isn’t realized until earnings are released.
Why Is Kroger Outperforming
Kroger is seeing strong same store sales for several reasons. Back in 2012, when Walgreens and Express Scripts “split up” briefly, many consumers with prescription drug needs went to Kroger stores to get them filled. This was a big deal, because Walgreens and Express Scripts controlled 21% of the pharmacy market is 2011. The Kroger Co. (NYSE:KR) has been aggressively trying to get a larger share of the pharmacy market. In November 2012, Kroger purchased the specialty pharmacy company Axium Pharmacy to get into the rapidly growing specialty pharmacy market. That market used to be 9% of total pharmacy revenues in 2006, but has since jumped to 17% in 2011. Kroger is using its new found “sticky” revenue from consumers with prescription drug needs to fuel its growth. It also revamped its customer rewards program a few years back, and that continues to resonate well with consumers.
What Kroger does is offer a rewards program where customers earn points for each dollar they spend at Kroger’s stores. Once they reach a certain amount of points, they can turn that into cash. This is a strong driving force that gets customers back into their stores, because if someone is about to earn themselves $25, then they are far more likely to go shop at Kroger than somewhere else. Kroger has combined its expanding pharmacy business with its revamped customer rewards program to boost sale stores sales, and thus the bottom line.
The Competition and Statistics
Kroger trades at a PE of 11.25, versus an industry average of 16.55. Safeway trades at a PE of 10 and is expected to grow at a slower rate than The Kroger Co. (NYSE:KR), while the goliath Wal-Mart Stores, Inc. (NYSE:WMT) trades at a PE of 14.7 and is also expected to grow at a slower rate. Both Wal-Mart and Safeway Inc. (NYSE:SWY) are seeing smaller same store sales gains at their stores, yet trade at PE levels similar to Kroger. This means that when Kroger is compared to other retailers, in a valuation sense it is a cheap stock. That justifies Kroger’s current valuation and shows investors that there could be another 30% upside in Kroger’s stock, if it was to reach a Wal-Mart Stores, Inc. (NYSE:WMT) valuation level.