Risk Reward Balances Kroger

Zacks

The Kroger Company (KR) holds a significant position among the nation's largest grocery retailers, and remains committed to counter the uneven recovery in the economy in order to keep itself afloat.

Positive Factors to Count Upon

Kroger's strong corporate and national brands help gain customer loyalty, sustain top and bottom lines growth, expand its store base and boost its market share.

The company's customer-centric business model provides a strong value proposition for consumers and positions it well to deliver higher earnings, primarily through strong identical supermarket sales growth (sans fuel). Identical supermarket sales are expected to increase between 3% and 3.5% during the fourth quarter of fiscal 2012. Alongside, the company's customer 1st strategy is reaping results.

Management continues to deploy capital to concentrate more on remodels, merchandising, and other viable projects. These include nearly 40 major capital projects comprising new store openings, expansions and relocations, and 100 to 125 remodels. The company expects to build, expand or relocate 50 supermarkets in fiscal 2013.

Kroger also remains optimistic about its acquisition of Axium Pharmacy Holdings Inc., a specialty pharmacy that is expected to boost the company’s drugs offering. Management continues to expect capital expenditures between $1.9 billion to $2.2 billion for fiscal 2012 and projected about $2.4 billion for fiscal 2013.

Efforts Reaping Results

Kroger’s third-quarter 2012 earnings of 46 cents per share beat the Zacks Consensus Estimate of 43 cents, and rose 39.4% year over year on the back of Customer 1ststrategy, effective cost management and share repurchase activities. Management now envisions fiscal 2012 earnings between $2.44 and $2.46 per share, up from a range of $2.35 to $2.42 forecasted earlier. Total revenue (including fuel center sales) climbed 5.9% to $21,807 million, and also came ahead of the Zacks Consensus Estimate of $21,664 million.

Challenging Economy & Intense Competition

The economy is not devoid of risks, and Kroger is not immune. The intensifying price war among grocery stores to lure budget-constrained consumers may adversely impact Kroger's sales and margins. The recent economic downturn has transformed the way consumers used to shop. Cash-strapped consumers are now prioritizing their purchases, choosing cheaper substitute brands and shopping for groceries at low-price leaders like Wal-Mart Stores Inc. (WMT) and Costco Wholesale Corporation (COST).

The grocery business is highly competitive and fragmented, and Kroger faces intense competition from big players, like Supervalu Inc. (SVU), and other conventional and specialty gourmet retailers with respect to price, store expansion, and promotional activities to drive traffic. This might weigh upon the company's performance.

Further, higher debt-to-capitalization ratio also remains a major concern. Kroger ended third-quarter 2012 with a total long-term debt (including obligations under capital leases and financial obligations) of $8,859.6 million, reflecting a debt-to-capitalization ratio of 70.2%, which is substantially higher, and could adversely affect the company’s credit worthiness and make it more susceptible to the macro-economic factors and competitive pressures.

Closing Remark

The above analysis supports our unbiased view on the stock, and therefore we continue to adjudge a long-term Neutral recommendation on Kroger, which operates 2,422 supermarkets and multi-department stores in 31 states under approximately 24 local banners. Moreover, Kroger's shares hold a Zacks #3 Rank that translates into a short-term 'Hold' rating.

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