A Great Time to Go Krogering
At this point, it’s practically piling on to write a positive post about the investment potential of Kroger (KR). Its performance has been well documented by Dan Moscowitz here at Motley Fool and contributors at similar services, and with good reason: 1) Kroger has grown same store sales for 40 consecutive quarters, including during the worst recession since the Great Depression; 2) Despite being a “defensive stock” with a beta well below 1.0, the stock has returned nearly 200% since 2002, and 3) Despite all of the above success, the stock continues to trade at a steep discount to similarly successful retailers – consider that Kroger recently traded at 11x forward earnings and compare that to Whole Foods (28x), Costco (22x) or Safeway (19x).
Kroger is currently trading at a 15% discount to its 52-week high, while peers such as Wal-Mart, Safeway and Costco are 8%, 11% and 9% off of their 52-week highs, respectively. The recent poor performance at Kroger versus its peers is largely due to a downgrade from Credit Suisse on January 16 that sent the stock tumbling 5%. The reasoning behind the downgrade was not terribly specific (“industry trends”) however it’s very possible that market psychology is working against Kroger in the near-term and the analyst was merely echoing that sentiment. Kroger is set to announce Q4 earnings on March 6 and it faces a tough comparison from Q4 of last year – earnings are expected to decrease from 88 cents per share to 73 cents per share in Q4. However, that temporary earnings decrease isn’t expected to last as next year earnings are projected to increase 12% versus the current year.
Investors with a trading mentality could look to start a position in Kroger starting now and build through the earnings announcement. Once the tough comp in Q4 is behind Kroger, at the very least it should be able to recover the 5% it has lost recently versus its peers.
Over the longer-term, Kroger’s prospects are even more promising. Kroger has been at the forefront of “Big Data” since 2002 and is now something of a legend for customizing promotions to its loyalty program members (which is amazingly, half of US households) and tailoring stores to meet local tastes. For instance, in some markets Kroger may offer 20+ brands of olive oil, while it others it offers only one. Kroger is also building its selection of local and organic products in many stores, where local tastes warrant the increase.
The utilization of data appears to be leading Kroger to a “barbell” strategy where it is able to tailor a mix of premium and generic products for a given market. For instance, shoppers in a given market may prefer premium or local produce but also want inexpensive private label paper towels or soda. The fact that Kroger has the flexibility to offer both in the same store sets it apart from Whole Foods, which would offer the premium produce along with premium organic paper towels and sparkling pomegranate water, or even Wal-Mart which would offer the discounted version of all of the above. This gives Kroger a powerful advantage with middle class consumers who want to splurge on certain items, but are still cost-conscious overall.
Kroger is now the second largest grocery retailer in the US, far behind Wal-Mart, but nearly twice the size of the third largest retailer, Safeway. As data and technology becomes more important in the grocery industry, the large and technologically adept will continue to distance themselves from the pack. Kroger continues to buy mid-sized grocers, as evidenced by the acquisition of Harris-Teeter that closed last week, and apply its successful strategies to those footprints. It is a simple and repeatable recipe for growth, both in sheer size and EPS.
Kroger rallied 2.5% today on news that it acquired a technology company focused on digital coupons and promotions. Nearly 30% of grocery shoppers now use mobile devices to help them shop for groceries, an astounding number that will only grow in time. The largest and most technologically savvy retailers, such as Kroger, will be in the best position to exploit this growing trend, again helping them separate from the pack. As the smaller retailers fall behind, Kroger will surely be there with a merger proposal that is accretive to Kroger's EPS and a winning strategy.