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.
Balance Sheet and Dividend
Kroger does have a significant amount of debt versus its cash, but that is common for retailers. As of its latest quarter, Kroger had $1.2 billion in cash and $6.18 billion in total long term debt. They pay out a dividend of 15 cents a share (1.95% yield), which is 3 cents higher than the 12 cent dividend they paid out a year earlier. The payout ratio on that dividend us 17.81%, which gives Kroger’s management ample room to boost the dividend further.
Going forward I expect Kroger to continue to increase its dividend by 3 cents a share within the next year. If you are a long term investor Kroger is a great stock to own because it pays out a steady dividend, can easily manage to pay the dividend, and will continuously increase that dividend for decades to come. Back in 2006 The Kroger Co. (NYSE:KR) paid out a dividend of 6.5 cents a share each quarter. In 2007 that increased to 7.5 cents, went up to 9 cents in 2008, went up even further to 9.5 cents in 2009 (keep in mind that the US economy was in a freefall and everyone thought the next depression was coming), and was at 10.5 cents in 2010. Even during times of economic peril, Kroger continued to serve investor’s best interests and boost its payout. That is a very bullish sign for a good company.
Even after Kroger’s run, the stock still looks like a buy. It continues to outperform, trades at cheaper ratios than the industry, has a promising future in the pharmacy business, continues to boost its dividend, and would be a great long term buy for any portfolio. Any company that has enough faith in its business to boost its dividend while the global economy goes through a massive recession is worth looking into. I think that Kroger will beat expectations going forward, just as it has done in the past. One thing to look out for is the payroll tax increase, but the bullish jobs data should mitigate that risk. Also, stronger than expected retail data for February should help. I’m still bullish on Kroger.
The article Why This Grocer Can Still Grow Your Greenbacks originally appeared on Fool.com and is written by Callum Turcan.
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