I see Kroger (NYSE:KR) as a stable company due to the nature of consumers’ behavior in purchasing groceries consistently regardless of how the economy is doing. Kroger reported a strong quarter for fiscal Q2 2020 (ending in August). Identical sales (excluding fuel) increased by 14.6%. Digital sales increased by an impressive 127%, contributing to a 4.4% increase to identical sales. The company achieved this even when faced with less government stimulus money in circulation and less SNAP funding, combined with less back-to-school activity due to online learning.
Kroger has improved the profitability of the digital business incrementally in Q2. The company is working on further cost reductions for the digital business through process improvements and automation. Kroger is also working on improving the sales mix by leveraging its personalization tools.
Increased Dividend and New Share Repurchase Authorization
Kroger increased the dividend payment by 13% earlier this year. This marks the company’s 14th consecutive dividend payment increase. Kroger also authorized a new $1 billion stock repurchase program to replace the previous one.
Kroger is able to increase dividends and do share repurchases from its strong cash flow. Kroger had $6.7 billion in operating cash flow and $3.9 billion in free cash flow over the past 12 months. Free cash flow accounted for 3% of total revenue. That may sound like a small percentage, but Kroger pulled in nearly $129 billion in revenue over the past 12 months. The company paid $517 million in dividends and repurchased $1.1 billion in stock during this time period.
The dividend has plenty of safety since the business itself is highly stable, allowing the company to generate consistent net income. The payout ratio is low at 24.27%. So, the company is paying less than a quarter of net income as dividends.
The dividend has been increased by a CAGR of 12.64% over the past 10 years. That is a decent annual raise for shareholders. Investors should be able to count on steady dividend payment increases going forward due to Kroger’s tendency to increase free cash flow over time.
Steady Stock for an Uncertain Market
When the market is tanking, it is good to have a stock like Kroger in the portfolio. Tech stocks are great during bull markets, but it is painful watching them drop sharply during market corrections and bear markets.
The good thing about Kroger’s business is that the company offers what consumers need on a regular basis. It is not practical for most consumers to order takeout or to eat at restaurants for every meal. That’s why consumers’ behavior of purchasing groceries on a regular basis provides Kroger with long-term revenue and earnings stability.
Kroger’s stock is not totally immune from market corrections. However, the stock has a beta of only 0.31 as compared to the S&P 500’s beta of one. Such a low beta makes Kroger significantly less volatile than the average stock. It is especially less volatile than many tech stocks that have betas above one. Therefore, stocks like Kroger can add some stability to a portfolio.
The overall stability for Kroger is a result of the consistency of its business. Groceries are not cyclical – they are purchased consistently regardless of how the economy is performing. While the stock is still likely to experience pullbacks during corrections, it is likely to bounce back and increase over the long term. Kroger’s stock pullbacks are likely to be less severe than stocks of companies that are more cyclical.
The recent market correction is leading to a more attractive valuation. Kroger’s forward PE ratio is now at 10.8, and the forward price to sales ratio is at a low 0.21. Before the correction, the stock was trading with a forward PE of 12.
This is significantly below the valuation of Kroger’s competitors and the broader market:
|Kroger||Walmart (WMT)||Costco (COST)||S&P 500 (SPY)|
Source: Seeking Alpha, ssga.com
Kroger’s valuation was attractive before the recent market pullback. It is getting more attractive as the correction continues. This gives investors a stock with a better valuation than many companies in today’s market, and Kroger is not a value trap. The company has strong fundamentals that can help drive steady stock increases from this low valuation.
Company Programs Aiming to Drive Growth
The Restock Kroger initiative which was launched in 2017 aims to keep the company competitive. Competitors such as Walmart and Amazon (NASDAQ:AMZN) have highly competitive grocery offerings and services. Kroger’s initiative is a multi-pronged strategy designed to increase the company’s competitiveness in the market.
Restock Kroger includes the partnership with Ocado (OTCPK:OCDGF) to run efficient, automated online grocery fulfillment centers. The automated fulfillment centers use order-picking robots to fill customer orders in an efficient manner. Kroger has plans to open a total of nine automated fulfillment centers to support its online business. The first three of these facilities are expected to operational in 2021.
Restock Kroger also includes expanding the product lines with 231 new items under the ‘Our Brands’ name. Other strategies as part of the initiative include personalized recommendations to customers, shelf-space optimization, smart pricing to retain customers, store redesigns for self-checkout, technology upgrades, alternative revenue streams, and investing in the workforce (pay, benefits, employee development). All of these initiatives can lead to increases in market share, revenue, and cost savings if they are proven to be successful.
The daily chart above shows that the RSI is bouncing higher from an oversold condition. The MACD line confirmed the change in trend from negative to positive as the green line crossed above the red signal line. The Chaikin Money Flow [CMF] has been increasing from a low level and could be heading to positive territory. Here is a good buy-the-dip situation, in my opinion.
Kroger’s Q2 results confirm the company’s ability to perform well in uncertain economic conditions. The company provides products/services that are needed on a regular basis. The consistency of the business leads to consistency in revenue and earnings.
The Restock Kroger initiative has the company on track for $1 billion in savings for 2020. These initiatives are likely to have a long-term multi-year positive impact on the business. It will be interesting to see how the automated fulfillment centers impact the online business in 2021 and beyond.
Overall, Kroger looks like a solid stock for good and bad economic times.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Business relationship disclosure: The article was written by David Zanoni for Kirk Spano’s Margin of Safety Investing [MoSI] service. Subscribers were able to get an early look to pick up the stock at a better price on September 22.
Additional disclosure: The article is for informational purposes only (not a solicitation to buy or sell stocks). David is not a registered investment adviser. Kirk Spano is an RIA. Investors should do their own research or consult a financial adviser to determine what investments are appropriate for their individual situation. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.