Kroger: Your Local Grocer
Posted on: September 24, 2008 - Email Article - Printable Version
After what has quite possibly been the craziest week in Wall Street history, many people are trying to figure out where to go in this market. While this may or may not be the bottom, it seems like Wall Street has gotten what it has asked for from the government: a solution for all the banks’ problems with bad debt, as opposed to the government just bailing out one firm at a time. Whether or not this was a good move is up for debate, but I will leave that for another time. As I have stated before, in such volatile markets, it is important to minimize at least some of the risk that you take on. That is where Kroger Company [KR: 26.64, -0.03 (-0.11%)] comes in.
Company Description
Kroger Co. is a one of the largest US supermarket chains, operating about 2,500 supermarkets, some of which operate fuel centers as well. The company operates stores in the following formats: combo stores, which are the local neighborhood supermarkets that you shop at; multi-department stores, which are larger than combo stores and have a similar offering to a store such as Wal Mart; and price warehouses, which are one stop shops for low priced goods in a warehouse setting. The firm also has 782 convenience stores and 394 fine jewelry stores.
The firm has three tiers of private label items: Private Selection, meant to meet or beat the gourmet brands, “banner brands”, which attempts to be equal or better to the national brand and Kroger value, designed to deliver goods at affordable prices for the consumers. Another important point of note is that all of the firms revenues are generated domestically, which can be both good and bad. With the recent surge in the dollar and possibility of a continued bull market for the dollar, the lack of international exposure should not hurt the company.
Customer 1st Strategy
While most retail stores have a collection of data on consumer shopping habits to support their supply chain, Kroger has taken this a step further with their loyalty program. Tracking what each individual consumer buys, where they buy and when they buy it allows the firm to shift strategies in an ever changing marketplace almost instantaneously. I think CEO David Dillon summed it up best during the last conference call:
“One of the most sophisticated tools we use to leverage opportunities in any economy is our vast collection of consumer data derived from our customer loyalty cards. We use this data to anticipate and respond to changes in consumer behavior. We’ve been building our extensive collection of consumer data since 1999. Today more than 40% of all US households [has] one of our shopper’s cards. As a result, Kroger has one of the largest retail consumer databases in America.
Our partnership with dunnhumby USA gives us valuable insight into our customer’s shopping habits. Through this insight we’re able to use our customer loyalty data to benefit our customers and increase their engagement with our stores. Our work with dunnhumby also allows us to segment our store base to offer customers in each store the right mix products and services. The store segmentation strategy and Kroger’s multiple formats allows us to meet the specific needs of various consumer segments.”
As the firm continues to operate they will continue to compile data based on macroeconomic conditions, as well as conditions in local markets, which should allow them to respond even faster to changing consumer needs well into the future.
Strong Sales Growth: Even in this Economy!
It is no secret that Kroger has performed well in this market. They had same store sales growth at 4.7% for their last quarter, with this quarters growth trending at 5%. Much like Wal-Mart [WMT: 56.74, +0.22 (+0.39%)], Kroger has withstood the economic downturn and has benefited greatly from consumers deciding not go to restaurants and eat at home. Not just that, but the consumers love the value brands that their stores offer, particularly their private label items, which have seen strong growth during the economic slowdown. Kroger also holds the #1 or #2 position in market share in 39 of their 43 markets. This is due to a combination of their customer loyalty initiatives as well their low prices. They also benefit from having fuel centers at many of the stores. Many customers are taking advantage of the fact that Kroger can serve as their one stop shop for all the goods that they need (both food and gas) to operate on a day to day basis. With the recent pullback in commodities, particularly oil, you can probably expect to see margins improve a little bit, at least in their fuel division.
Risks
There are two main risks I see when considering an investment in Kroger: large amount of debt and labor relations.
- Large Amount of Debt - KR has about $7.6 billion in debt outstanding as of the end of their Q208. While this number has decreased from the beginning of the year, it still poses a threat if the firm needs to raise more capital. It could also be a problem if they want to refinance their maturing debt, which could cause them to use substantial cash flow to make payments on their it. It could also adversely affect their credit rating in the future.
- Labor Relations - A majority of KR’s employees are covered by collective bargaining agreements and major contracts are set to expire in 2008. This could cost the firm as employers look to maintain or increase their benefits, of which the costs are increasing, making it harder for firms to maintain these benefits. While they have yet to experience any problems in their current negotiations, a setback in these could cause the company to sacrifice some profits in the near term.
Valuation
- P/E (ttm): 14.67x
- P/E (forward): 12.64x
- PEG: 1.53x
- Price/ Sales: 0.26x
- Debt/ Equity: 1.47x
- Dividend Yield: 1.30%
On a P/E basis it seems as though KR is undervalued, as it is trading near the lows it has had in the past few years. In comparison to some of its competitors, like CVS [CVS: 30.33, +0.53 (+1.78%)] and Costco [COST: 52.51, +0.22 (+0.42%)], it also seems to be trading at a discount. While Kroger may not be as big as these firms, their strong sales growth, market share and continued performance in a tough economic environment should merit their ability to trade at a higher P/E. With solid earnings growth and a consistent dividend the stock should continue to return value to shareholders in the long term. As long as people need their groceries and Kroger keeps compiling their sales data, they should be able to excel.
-Vinay Ayala
Disclosure: The author does not hold a position in any of the stocks mentioned.
The Following Stocks Were Mentioned In This Article: KR
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Vinay - I think Kroger would be a great short-term play if it weren’t for their current debt situation. A 1.5x debt/equity ratio in this market is killer, especially since their current maturities are relatively high. While I like them in the short term to outperform Whole Foods due to weak consumer spending (WF is definitely a more discretionary-like grocery store), I see the trend towards healthier eating benefiting Whole Foods in the long term.