Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)  

Shares of Kroger (KR) ended trading last week on a strong note. The supermarket chain reported a strong set of fourth quarter results on Thursday before the market open. Shares ended Thursday's trading session with gains of approximately 3% and gained a similar percentage during Friday's trading session.

Fourth Quarter Results

Kroger generated fourth quarter revenues of $24.2 billion for the final quarter, up 12.8% on the year before. Sales growth was driven by the fact that the fourth quarter contained an extra working week. Excluding the extra week, sales were up by 3.7%. Identical supermarket sales growth for the quarter came in at 3.0%, just below the full year growth rate of 3.5%, and the third quarter growth rate of 3.3%. The quarter marks the 37th consecutive quarter in which Kroger managed to increase its identical sales.

Kroger's gross margins compressed by 13 basis points in the fourth quarter, coming in at 20.9%. Strict cost control on selling, general and administrative expenses saved the day. These expenses made up just 15.3% of sales, down an incredible 500 basis points on the day. The always volatile LIFO charges could explain merely 10% of the total improvement. Furthermore, last year's results were severely impacted by higher pension costs charges.

Net earnings for the quarter came in at $461.5 million, or $0.88 per diluted share. Net margins for the quarter peaked at 1.94%, a decent net margin for a supermarket chain like Kroger. Last year, Kroger reported a $306.9 million loss for the quarter, mainly driven by a big charge on its pension plan.

Earnings were driven by the fact that the fourth quarter had an extra working week, adding $0.11 per share in fourth quarter earnings. Adjusted earnings which exclude $0.11 in tax and LIFO benefits came in at $0.77 per share, ahead of consensus estimates of $0.70 per share.

Looking Into The Full Year Of 2013

Kroger looks with confidence into 2013, as it expects to report full year earnings between $2.71 and $2.79 per share. While the guidance is roughly equivalent of full year 2012's earnings of $2.77 per share, Kroger sees full year earnings growth compared to 2012's adjusted earnings of $2.52 per share.

Adjusted earnings correct for the effect of the additional week in the fourth quarter and the benefit from the credit card settlement.

Identical supermarket sales for 2013 are expected to increase between 2.5% and 3.5%.

Valuation

Kroger ended its full year of 2012 with $237.9 million in cash and equivalents. The company operates with approximately $8.9 billion in short and long term debt, for a sizable net debt position of $8.7 billion.

Kroger reported annual revenues of $96.8 billion for 2012 on which the company net earned $1.5 billion, or $2.77 per diluted share.

Factoring in Thursday's and Friday's gains, the market values Kroger at around $16 billion. This values the firm at 0.2 times annual revenues and approximately 10-11 times annual earnings.

Kroger pays a quarterly dividend of $0.15 per share at the moment, providing investors with a 1.9% dividend yield.

Some Historical Perspective

Shareholders in Kroger have finally seen some favorable action amidst a broad-based market rally in recent months. Shares traded as high as $30 back in 2007 and 2008, but have ever since traded in a relative tight trading range of $20-$25.

Over the last year, shares have rallied hard from lows of $21 in July of 2012 to levels around $31 at the moment. As such the stock is trading within reach of all time highs set in the low thirties back in 1999.

The latest rally in Kroger's stock price has been supported by stable, but increasingly expanding operations. Annual revenues grew little over 25% between 2008 and 2012, expanding from $76.2 billion in 2009 to $96.8 billion over the last year. Earnings grew some 20% from $1.25 billion to $1.50 billion over the same time period. Earnings per share grew even faster as a disciplined financial strategy by means of share buybacks has reduced the number of shares outstanding by some 20%.

Investment Thesis

In the past months investors finally seem to realize how much value Kroger is generating for them. The company continues to grow its business by reporting decent identical supermarket sales growth, while continuing to open new stores. The big driver in earnings growth and value creation has been strict cost control and a shareholder-friendly financial strategy employed by the firm.

The main story behind this margin expansion are selling, general and administrative expenses which fell an incredible 160 basis points for the full year to 15.3% of total revenues. Again, last year's full year margins were negatively impacted by one-time charges, including pensions costs.

Note that small operating margin improvements have a huge impact for Kroger, which typically results very low net margins. As a result of strict cost control, operating income doubled from 1.4% to 2.8% for the year of 2012. Consequently, net margins even more than doubled to 1.7%. The flexibility and strict cost control is remarkable for a supermarket giant like Kroger, which employs some 343,000 workers.

The prospects for 2013 remain solid as CFO Mike Schlotman anticipates food inflation to remain moderate, around the mid-1% range. The chain furthermore anticipates a modest pace of store openings, as it expects to open some 50 stores during the year, and solid identical supermarket sales growth.

Some investors are worried about the rapid slowdown of the pace of share repurchases. Kroger only repurchased 2.2 million shares in the final quarter, or $57 million worth of shares. For the full year of 2012, Kroger repurchased for approximately $1.2 billion worth of shares, with another $466 million being authorized at the moment. Management stresses that the slowdown in repurchases is tied to maintaining its debt ratios, and this should not be seen as a signal that management believes shares are overvalued.

The last time that I took a look at Kroger's prospects was at the start of December of last year. At the time, shares were trading at $26 per share and I argued that shares offered good value at those levels. Today I reiterate that stance. Shares offer decent value at 10-11 times earnings, while growing same store sales by approximately 3% and paying out a 2% yield.

Source: Kroger: Expense Control, Solid Growth Send Shares Toward All-Time-Highs