Getting Defensive: Kroger Is Undervalued

With a more than 40% rally in equities in the past 3-plus months, some investors are trying to ratchet down the risk in their portfolios. This would seem to be a logical move that should allow investors to participate from further gains, but also protect themselves against a major market decline.

One company that is reporting earnings on Tuesday morning looks poised to meet that need for a cautious investor. The Kroger Co. (KR) operates the largest chain of supermarkets in the country, and, throughout the downturn in the wake of the credit crisis and the collapse of the housing market, Kroger been range bound between $20 and $30. However, Kroger has benefited from the behavior of consumers during the recession, and the trend of consumers eating in is unlikely to end anytime soon.

We expect that Kroger will report sales growth of about 5% in the quarter just ended, and should be able to sustain that growth through the next quarter as well. The obvious reason is that it is cheaper for consumers and their families to cook at home rather than eat out at restaurants. Furthermore, Kroger makes its own store brands that are often cheaper than national name brands.

Today, a study conducted by Catalina Marketing’s Pointer Media Network showed that brand loyalty was under assault in 2008, as shoppers were simply not as concerned with the packaging as they were for the price. This trend only serves to support Kroger’s private label products. U.S household savings rates are at their highest levels in 15 years, and with gas prices on the rise yet again, consumers will likely start cutting back on unnecessary expenses. You will be hard pressed to find anyone that considers the groceries as an expense that can be cut to a great extent. People have to eat and the alternatives to groceries are almost always more expensive.

Kroger is a stock that is positioned well to take advantage of the ongoing consumer trends, but you wouldn’t know it from the recent performance of the stock. The S&P 500 has outperformed KR since the market bottom by a whopping 21%. In fact, the stock is still only about 12% higher than its 52-week low (52 week range: $19.39-$30.99). At the current price, the stock is trading at just over 10.7x expected fiscal 2010 earnings. Compared to historical valuation metrics, Kroger is Undervalued when utilizing our valuation methodology. For example, price-to-cash earnings over the last ten years has ranged between 6.0x to 8.7x and the current metric is only 5.2. Additionally, Kroger shares are 20% below the low end of their historical range of price-to-sales.

At Ockham, we think that it is wise for investors to periodically reassess the risks contained in their stock portfolio. If you are starting to feel uneasy about the risk associated with your stocks, Kroger is a solid company with plenty of appreciation potential in good times and minimal downside in the bad times. Obviously, we will know more after the earnings release and conference call tomorrow, but barring a major surprise we think this stock is worth a close look.

Original article

Comments

[User 357705:]

People won't stop eating but when fuel prices go back above $4 a gallon the food you'll eat will be allot more expensive. In US most of your food travels more than 1500 miles from the field to distribution center. Fresh veggies in the winter will travel 2500 miles. With fuel so high those freight rates will go from $3500-5000 to $7000-8500. Last year produce from CA to east coast was $10k just for the truck to the distribution center. People will eat yes, they'll eat allot less and that can't be good for grocery retailers caught in the middle.

Jun 23 09:22 AM

[Rhino Realty:]

I suggest buying shares of a public or private REIT that invests in Kroger anchored centers. This will provide you with a likely 7% dividend and an inflation hedge as most grocery leases have percentage rent and the investor should benefit from price increases via percentage rent. Another good bet is Delhaize (DEG), a Belgium based chain that owns East Coast market leader, Food Lion (BBB+).

Jun 23 10:35 PM