Kroger Supermarket Disappoints and Lowers Guidance

Kroger (KR) is the nation’s largest supermarket chain, and has benefited from the consumer eating at home more often during the recession. Furthermore, store brand items have been selling better in the last few quarters because of the trade-down effect. However, Kroger reported a more difficult quarter than analysts had expected earning just $254 million or 39 cents per share, compared to $276 million and 42 cents per share last year. Wall Street was expecting earnings to grow to 44 cents per share, and clearly the disappointing quarter is hurting the stock, down nearly 8.5% in morning trading.

Analysts were expecting sales to show a slight gain over last year, but instead they slipped about 2%. Perhaps this is attributable to more people eating out again as the economy has started to improve, but we think it is more likely that consumers are continuing the trade down trend towards discounters such as Walmart (WMT) and Costco (COST). Kroger has rejected offering quarterly guidance, but they have lowered their estimates for the full year. They now expect to earn between $1.90 and $2.00 per share, which falls below their previous guidance for $2.00 to $2.05.

Management said that the worse than expected quarter reflected changing consumer behavior and other factors related to the economic environment. Furthermore, they said that they expect that these difficulties will effect the company for the rest of the year. One of those concerns would be the deflation on food prices hurting sales totals for Kroger. Previously, we had thought that Kroger’s strong store brands and cost conscious consumers would help out Kroger more than hurt it, but we are starting to wonder about that thesis now. Perhaps consumers are so cost conscious that they are willing to go the extra mile in order to achieve additional savings at the bigger discount retailers.

Kroger stock has been range-bound between about $19.50 and $23 since last February, and after Tuesday’s weak results they are trading near the 52-week low. Although, Tuesday’s announcement is disappointing we think that this is a value opportunity for the defensive minded investors. Sales and earnings did disappoint, but the company is still fundamentally strong and selling at a substantial discount to the historical norms. For example, Kroger is trading well below its ten year price-to-cash earnings average range of 7.4x to 10.7. Likewise, price-to-sales is currently about .18x, but historically a range of .24x to .36x has been where the market values KR stock.

We are not saying that the difficulties are behind Kroger, but rather that for a long term value investor it is Undervalued. The results from the last quarter are a concern, but if you believe that consumers have shifted priorities and are going to be less likely to spend where it is unnecessary then Kroger is a good bet. It is trading at a more attractive multiple than Walmart and half the multiple of Costco, even after considering Kroger’s more conservative full year earnings guidance. Today’s sell off may be a great opportunity to buy an industry leader cheaply, and we would not be surprised to see it selling near $30 in two years time.

Comments

[rrtzmd:]

...I own SVU which got a slight hit because of Kroger's report...I reviewed Kroger's earnings and don't see much to complain about...the fact they made any money at all in the current economic environment is practically a miracle...

Sep 15 03:04 PM

[Joe Duggins:]

Retailers are not classic defensive issues by any stretch of the imagination, but if there is one, it is the 800-pound gorilla in the room we've long been calling by its given name: Wal-Mart.

Witness the performance of the retail giant in an economy that is somewhere between unpleasant and outright recessionary: In a climate that has seen retailers all over the country slam shut their doors and add workers to the unemployment lines, Wal-Mart continues to motor along. The company retains the capacity to cut prices aggressively, and shows no disinclination to doing so when it's time to win over the consumer. At this writing, Wal-Mart's share price is less than a dollar away from its 52-week high, and this at a time when seemingly every other stock out there is hitting new lows with a resounding thud.

We're all familiar with the usual staples of defensive investing...utility companies, drug companies, food companies; manufacturers of all the stuff you need, no matter what happens. Wal-Mart is not a manufacturer of any defensive products, but is becoming perhaps the best place, in terms of price, to buy a lot of those defensives; the company remains the leading grocery retailer in the United States, and Wal-Mart is still roaring along with its $4-per-30-day supply program of over 360 drugs.

The point is that every bit as important as the companies that manufacture the "gotta haves" are the few companies that make those products available at affordable prices...and Wal-Mart remains at the top of that list.

The string of Consumer Price Index readings so far here in 2008 indicates only better days ahead for Wal-Mart; that measurement has been climbing just about every month this year (it was flat in February), and does so largely on the basis a rise in food and health care costs...goods that remain a great deal at Wal-Mart.

I have never fashioned myself a classic Wal-Mart shopper, but times have changed. Money is tight for everyone these days, and while I don't love every aspect of the Wal-Mart shopping experience, I am driven to spend my money there in an effort to save some...and I'm not the only one. I've spoken to many Wal-Mart shoppers who've said that while they don't like certain things about the company itself (Wal-Mart has a somewhat checkered history in the area of employee relations, and many people resent Wal-Mart's crushing presence on small, local businesses), they shop there anyway because, well, principles invariably take a back seat to the wallet when it comes to surviving in bad economies.

The key to Wal-Mart's continued success is going to be the degree to which the company can permanently win over the customers who are now shopping there, in their own minds, only temporarily. As I said previously, you can count me as one of the many who don't particularly enjoy the overall shopping experience, but if Wal-Mart can change that so that those who are just "stopping by" for now will remain when the economy is functioning again on all cylinders, you may well have a company...and a stock...that is strong in good times...and even stronger in bad. Good luck in finding another one of those.
----------------------...
Money without intelligence is like a car without a road.
www.intelligentinvesti...

Sep 15 05:13 PM

[Mark Krieger:]

Today's drop is classic buying opportunity. KR's PE is much lower than the S&P 500 index average. The whole sector is inviting.

Sep 15 10:35 PM

[ebndr:]

some dangers in KR latest quarterly earning conference

company notes of slow end of month sales which starting to look like a trend. management tried to explain this by saying something about lower prices which does not correspond well with the strong unit volume. my idea is that competitors are taking customer away at end of months.

Co note that loyal customers recently added are those who are value seekers and price sensitive. I'd say this does not bode well for the sustainability of KR market share and performance trends over the long term. taking market share from WMT when you are 80% unionized is not something you willingly want to do. and those "loyals" will disappear later on.

there for it appears that SWY which is trying to differentiate using customer service and shopping experience is the better way to go.

disclosure: long SWY

Sep 16 07:38 AM

[Paul Price:]

I agree with Mark K.

The news was far from bad with the revised EPS still at, or above, last year's all-time record $1.90 /share.

Kroger's valuation is compellingly cheap and its yield is better than what's now available on bank CDs and short-term treasuries.

KR is a buy- not a sell.

Sep 16 09:52 AM