Kroger (NYSE:KR) is a large retailer, at an approximately $12 billion market cap. It is best known as a grocery store, and best compared to other grocery stores, but also operates a number of department stores which sell other goods. Grocery stores are not an exciting business, but they can sometimes make good value investments due to low valuation multiples. With Kroger having declined 13% so far this year, is the stock at a good entry point?
One strength of Kroger as an investment is that its beta of 0.4 indicates that movements in its stock price have little relationship to broader movements in the market. If an investor believes that growth in the U.S. is slowing, or that the stock market is going to go through a bearish phase, a large-cap grocery store may make a good investment. Alternatively, an investor may be invested in select consumer discretionary stocks and be looking for a way to diversify in the event of a market downturn.
Kroger’s most recent 10-Q showed a fairly small increase in revenue, some of which dropped down to the bottom line for an increase in earnings per share from 71 cents in the same period in the previous year to 79 cents. Operating cash flow also rose. Revenue growth was led by fuel sales as gas prices rose in the quarter, but supermarket sales ex fuel rose as well. The number of stores in operation did not change much, as would be expected from a large grocer, and so same-store sales and total revenue were both up between 5 and 6%.
Looking forward, the company could encounter trouble. Kroger and other grocery stores face concerns that food prices are rising and that it may be difficult to pass these price increases on to consumers who are already struggling with slow-growing incomes. Passing on these price increases could be a necessity for Kroger’s stock price: its trailing price-to-earnings ratio is 21, remarkably high for a grocer with little to no growth and little to no margin (0.66% on a trailing basis). Wall Street analysts give the company generous earnings estimates, bringing the forward P/E to below 9, but if food inflation squeezes margins any closer the company is in danger of negative profits. The EV/EBITDA multiple of 5 is also in value territory, and Kroger does pay a 2.2% dividend yield, but an investment in the business is still not necessarily appealing.
According to 13F filings from the first quarter of 2012, the largest hedge fund holder of KR is East Side Capital, under the management of Steven Richman. Richman owned 5.7 million shares of Kroger and it was the fourth largest position he reported (see his other favorite stocks). East Side Capital had initiated this position in the summer of 2011. Famed quantitative investor Cliff Asness’s AQR Capital Management owned 1.6 million shares of Kroger and hedge fund giant D.E. Shaw owned another 1.5 million shares, but these were fairly small positions considering the size of the funds’ portfolios. There has been some insider selling at Kroger recently but the largest sales have been of management’s stock options, which is not a particularly bearish sign.
Kroger’s closest comp is Safeway (NYSE:SWY). Safeway is actually a stronger value stock in many ways- a trailing P/E of 8, and EV/EBITDA ratio of 4.5, and a dividend yield that is over twice Kroger’s at 4.6%. Casey’s General Stores (NASDAQ:CASY) is priced more for growth, with P/E ratios in the teens and very low earnings growth in its most recent quarter compared to the previous year. The more premium Whole Foods Market (NASDAQ:WFM) boasts a greater market capitalization than Kroger, at over $17 billion following its 11% rise today. Whole Foods draws this market cap based on its higher valuation multiples, with a forward P/E of 33. However, Whole Foods has recently reported strong quarterly earnings growth and tends to deliver positive earnings surprises. We believe that Kroger might be a good addition to a value investor’s portfolio, and trumps some of its peers in that regard, but that Safeway’s remarkably low valuation makes it a better bet.