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Kroger: Margin Woes Limit Upside?

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Kroger (KR) recently delivered stronger-than-anticipated Q2 results. Furthermore, America’s largest supermarket chain operator raised guidance that exceeded Street’s expectations. Despite the beat and raise, Kroger stock came under pressure and closed 7.5% lower on Friday. (Read more: Kroger Falls 7.5% Despite Beating Q2 Expectations, Lifts Guidance)

The decline in Kroger stock can be attributed to its weak margin performance. It’s worth noting that Kroger, along with other food retailers, continues to face tough year-over-year comparisons. Furthermore, investment in price to drive traffic and supply-chain woes is taking a toll on food retailers’ margins, including Kroger. I have a Neutral outlook on Kroger stock. (See Kroger stock charts on TipRanks)

In Q2, Kroger’s FIFO (First In, First Out) gross margin, excluding fuel, fell by 60 basis points compared to the prior year. Moreover, it also came about 55 basis points lower than the pre-pandemic levels. Kroger’s gross margin decline reflects its continued investment in price coupled with higher shrink and supply chain costs.

Looking ahead, Kroger expects supply-chain costs to remain elevated for the second half of the year, implying continued pressure on margins. Furthermore, investment in price could continue to weigh on gross margins.

In response to Kroger’s Q2 performance, Karen Short of Barclays highlighted Kroger’s weak gross margins. She reiterated a Sell rating on Kroger stock but raised the price target to $37 (13.3% downside potential) from $35.

Meanwhile, Matthew Fishbein of Jefferies expects “headwinds from warehouse and transportation costs, increased shrink, and price investments all likely to persist” and more than offset the benefits from “higher food inflation outlook and better fuel margin environment.”

Fishbein maintains a Hold rating on Kroger stock. Meanwhile, he increased the price target to $40 (6.3% downside potential) from $38.

Overall, on TipRanks, Kroger commands a Hold consensus rating, based on 2 Buys, 10 Holds, and 3 Sells. The average Kroger price target of $39 implies 8.6% downside potential to current levels.

Disclosure: On the date of publication, Amit Singh had no position in any of the companies discussed in this article.

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