Should You Buy Kroger Co? 2 Pros, 2 Cons
Kroger dropped 12% after reporting a disappointing profit outlook
The company’s windfall from tax cuts is being spent to stave off competition
KR stock is now down roughly 45% from its all-time high
Kroger Co (NYSE:KR) reported earnings Thursday that largely hit all its targets, yet investors still voiced displeasure by voting down Kroger stock by nearly 13%.
As I mentioned, earnings weren’t the problem. Per-share earnings of 63 cents met the consensus; same-store sales of 1.5% came in precisely on target; revenues of $31 billion eeked out a gain against expectations of $30.9 billion …
So why the displeasure?
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For one, full-year net earnings came in at $1.9 billion versus $2 billion in the year-ago period. What really dented KR shares, however, was Kroger’s profit forecast for 2018 — $1.95 to $2.15. That’s a midpoint of $2.05 versus the $2.15 analysts had hoped for.
Kroger CFO Mike Schlotman told CNBC he believes the market expected too much of Kroger’s tax windfall, which the company will distribute equally to its customers, employees and shareholders:
“I know there are some analysts out there that put way more than that in their initial estimates for our next fiscal year, and I’m sure that’s causing a little bit of consternation as they look at the numbers,” said Schlotman, referring to the hope analysts had for Kroger’s tax windfall to go straight to its bottom line.
If this sounds like an overreaction and you’re considering buying the dip, begin your research with this article by evaluating the pros and cons of owning KR stock.
Kroger’s Pros
Size and Focus: The “Amazon Effect” has hurt Kroger stock and then some. Think about it like this: Amazon.com, Inc. (NASDAQ:AMZN) announced it was buying Whole Foods way back in June and KR stock is still down 25% from that day. While many obviously see Amazon’s Whole Foods as a threat, the case can be made that Kroger is much bigger than Whole Foods and KR serves a different market entirely. Consider that KR has 2,782 supermarkets and multi-department stores in 35 states (and DC) while WFM has around 473. Kroger is also the largest pure-play grocer in the U.S. if you back out Walmart Inc (NYSE:WMT) and Costco Wholesale Corporation (NYSE:COST), which offer much more than groceries. One little acquisition, even by Amazon, doesn’t mean every supermarket in town is doomed.
Aquisition potential: Much like Amazon snagged Whole Foods, there’s speculation that Alibaba (NYSE:BABA) could pick up Kroger. Back in December, Alibaba and Kroger execs met in China to discuss increasing Kroger’s presence in China. So yes, a buyout is still speculation, but the benefits of such a deal are obvious for both companies. For one, it gives Kroger an edge to compete against Amazon’s technology with Alipay. Plus, Alibaba also has aspirations for an unmanned store. Buying Kroger gives Alibaba a chance to build an army of Amazon Go-like stores in China, where “frictionless shopping” is already blazing full-steam ahead.
Kroger’s Cons
Competition: If the way Kroger is spending to keep itself relevant is any indication, it certainly has competition to watch out for. Aldi and Lidl are two European low-cost grocers making Kroger’s life a living hell. As these stores expand, they encroach on Kroger territory and attract shoppers who then become addicted to lower-priced goods. In turn, Kroger must lower its prices. Then there’s Walmart, which is looking to expand further into groceries, specifically meal-kit delivery. And while Kroger is rolling out its “Scan, Bag and Go” technology to 400 stores this year, both Walmart and Amazon have deeper pockets and more technological savvy to step on Kroger’s toes in this arena.
Lack of Growth: Even if Kroger’s valuation took too much of a hit yesterday, without an acquisition KR stock is close to maxed out. The saving grace of a lone-Kroger narrative was that it was still making small increases in market share and still growing gross margins. Now that its margins look to be pressured as it doubles down on its cash to battle Amazon, Walmart and others, there’s just mid-single-digit sales growth to look forward to. Consequently, while it was growing earnings at a 10% clip for the past five years, the next five years are a meager 1%.
Bottom Line on KR Stock
Buying KR stock comes down to what kind of investor you are. If you think KR stock was the victim of an overreaction and you bought yesterday at, say, $23.07, you’d be up 3% by now. If you think that Jeff Bezos & Co. are pioneering the future of grocery stores in America, and that Alibaba buying Kroger is a pipe dream, then you probably don’t see much growth in Kroger shares over the long term.
But if you are leaning toward buying Kroger, its dividend could tip the scales for you.
KR pays 12 cents quarterly. That’s a yield of 2.15%. It’s a pretty stable dividend, too.
For the past nine years, Kroger has increased its payout to shareholders. Considering that Kroger ended 2017 with $4.2 billion in operating cash flow, it has enough cash to keep that payment growing for the long term.
And while Kroger didn’t use the windfall from the tax cuts to buy back shares or increase its dividend, take it as a good sign that management is reinvesting in the company to stave off competition.
John Kilhefner is the deputy managing editor of InvestorPlace.com. As of this writing, John Kilhefner was long Kroger stock.
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