Kroger Gains Back Market Share from Wal-Mart

Kroger (KR) reported its second quarter earnings on Tuesday morning, September 15th, 2009. Earnings were 39 cents vs. 42 cents a year ago, disappointing analysts whose consensus view was 4 cents higher. Sales for the quarter were fractionally lower, as well - $17.74 billion vs. $18.09 billion in the year ago quarter. Here again, analysts expected a slight improvement vs. last year. Kroger also trimmed its profit projections for the year down to $1.90 - $2.00 range. Predictably, market players punished the stock trimming its value by 8%. At one point during Tuesday’s trading Kroger was trading at a low of $20.19, only 4% above its three year low of $19.39, reached on March 9th of this year.

To better understand the value that Kroger shares currently present, let’s take a closer look at the latest results. Hiding behind the top layer are the comparable store numbers. Excluding fuel, comparable store sales were up 3% or $425 million vs. the year ago quarter. Increases in these numbers are great news in the face of deflationary pressures and cost cutting that the industry has undertaken over the past year. The only way Kroger could achieve such results in non-fuel categories is by taking market share away from its competitors.

An important question to ask is how well did Kroger’s low price strategy work in Q2 to compete with Wal-Mart (WMT). Wal-Mart is the only retail giant that is larger than Kroger and over the past two years it has made great inroads into Kroger’s core competency – food retailing. Reviewing Wal-Mart’s recent 10Q for Q2, notice that total comparable US store sales declined 1.5%, marginally worse than Kroger’s 1.3%. More importantly, however, the report’s footnotes tell us that fuel sales made up only 0.9% of this decrease. This means that excluding fuel sales, Wal-Mart’s comparable US numbers still declined 0.6%. Wal-Mart does not report what percentage of US revenue they derive from gasoline sales, but $3.7 billion or about 5% of their Q2 total US sales is a good assumption. Thus, it looks like Wal-Mart’s US non-fuel sales were down around $439 million vs. Q2 2008.

Kroger is gaining in non fuel sales almost exactly what Wal-Mart has lost, which certainly looks like the taking back of market share form the giant. And the Kroger story only starts there. Did you know that the new Kroger low price strategy is not so low in price? Instead, Kroger mostly expanded on the use of price leaders – something that they do better than any of their competition. Another area where Kroger beats out competition flat down is in the use of store brands - they sell lots of them and at higher average margins. Oh, and let’s not forget vertical integration. Did you know that Kroger actually owns several dairy farms? That’s how they were able to quickly bring the price of a gallon of milk back down to $1.58, as prices of cattle feed plummeted along with agriculture commodities. Milk, by the way, is traditionally one of the best price leader products for grocery stores.

Now, let’s see how well Kroger actually did in the fuel department. We can arrive at the change in fuel volume sold by looking at the average retail gas prices for Q2 of 2008 and 2009. By averaging the 13 weekly U.S. Department of Energy all grades all formulations retail prices for each of the quarters, we get a Q2, 2009 average price of $3.83/gallon vs. Q2, 2008 average price of $2.39/ gallon. Kroger’s fuel sales in the year ago quarter were $2.23 billion, while this year’s Q2 brought them only $1.59 billion in fuel sales. At average prices that’s an almost 15% growth in gallons sold – not bad at all.

Technically, Kroger shares have been in a downtrend since the summer of 2008. An overriding shorter term mild uptrend emerged in February of this year. The two trends are now in a tug of war for dominance. Tuesday’s KR price action took shares 5% below their 60 day moving average on high volume. Technicians generally see this as a bearish sign. I tend to think of it as the market overreaction presenting at least a short term buying opportunity for Kroger.

Disclosure: I used the opportunity to buy a full position in Kroger on Tuesday morning at $20.47

Comments

[malach hamo...:]

pretty faulty logic when you consider that Kroger is almost all food, while Walmart includes both food and a large component of discretionary non-food consumer durables.

A drop in sales of air conditioners by Walmart doesn't mean it's still not taking food business from the grocers.

Sep 17 06:51 AM

[iggyDalrymple:]

I wasn't aware that WalMart sold much gasoline. The gas
stations on WalMart sites around here are branded MurphyUSA.

Sep 17 02:17 PM

[Sharon Merkle:]

"Net sales
for the Walmart U.S. segment increased 3.8% for the first quarter of fiscal 2010
compared to the first quarter of fiscal 2009. The increase resulted from our
continued expansion activities, strength in the grocery and health and wellness
categories and a comparable store sales increase of 1.6%."
- WMT: Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the quarterly period ended April 30, 2009.
investing.businessweek...

"Comparable Supermarket Sales
($ in millions)
First Quarter 2009 2008
Including fuel centers $21,306 $21,483
Excluding fuel centers $19,729 $19,075

Including fuel centers (0.8)% 9.5%

Excluding fuel centers 3.4% 5.9%"
- KR QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
investing.businessweek...

Kroger increased its same store sales more than WalMart, while WalMart explicitly linked its smaller increase to groceries, not air conditioners. Research your stones before you throw them.


On Sep 17 06:51 AM malach hamovess wrote:

> pretty faulty logic when you consider that Kroger is almost all food,
> while Walmart includes both food and a large component of discretionary
> non-food consumer durables.
>
> A drop in sales of air conditioners by Walmart doesn't mean it's
> still not taking food business from the grocers.

Sep 17 04:54 PM

[fcharlie:]

Please tell me where you found the information about Kroger owning dairy farms. I can't find any mention of it in the filings.

Sep 17 05:01 PM

[Jake Berzon:]

iggyDalrymple, I recall, most Wal-Mart's gas sales coming from their Sam's Club locations, but there are also those at the Wal-Mart locations. They may sell it under their own name or some other name. They may also contract gas sales to a third party at some locations, the way they do pizza (Papa Murphy's), sandwiches (Subway) and taxes (Jackson Hewitt).

fcharlie, you can find this and much more interesting information on Kroger in their annual factbooks available on the Kroger site: www.thekrogerco.com/fi... . I have also seen some info on the dairy farms in a recent filing.

Sep 17 06:58 PM

[fcharlie:]

Jake,

are you confusing owning farms with owning dairy processing facilities? I see no mention of farm ownership in the fact book.

Sep 17 08:33 PM

[User 487967:]

They do not own dairy farms, they own Dairy Manufacturing Plants which buy tankers of raw milk and process the milk into Ice cream, cultured products and of course gallons, half gallons, qts and pints of milk


On Sep 17 05:01 PM fcharlie wrote:

> Please tell me where you found the information about Kroger owning
> dairy farms. I can't find any mention of it in the filings.

Sep 18 02:31 AM

[User 487967:]

they only own dairy manufacturing plants not farms

Sep 18 02:33 AM

[Jake Berzon:]

fcharlie, I said that they own dairy farms and they do. I never said that Kroger actually milks cows, which is what you are implying. I believe Kroger contracts this function. Unless your land is on the books at 1950s prices, it's darn near impossible to make money milking cows.

Sep 18 02:45 AM

[fcharlie:]

This is the problem with Seeking Alpha. Anyone can write anything they want. Kroger doesn't own any farms. Now you're saying that I said or implied that they "milk cows". You wrote an article that blatantly said "Did you know that Kroger actually owns several dairy farms" It's not true. And now that you can't reference any mention of this in the 10-K, you say you "believe Kroger contracts the function of milking cows", which isn't very convincing that you know what you are talking about.

I'm not trying to be a jerk, and I will sincerely apologize if you can cite any filing that Kroger owns farms. All you've done is cite manufacturing facilities that have the word 'farm' in their name. I'm in the process of making Kroger a major holding for myself, and I try to know as much as possible about a company. I'm not arguing for the fun of it, I just want an answer, and I think I've found it.

Sep 18 11:50 AM

[Jake Berzon:]

I used the same term "dairy farms" that Kroger does to describe their dairy operations. I am sorry that this caused confusion. The operations are generally located along the railroad tracks away from large city centers and within reasonably close proximity of the cows. Since there are no cows at the facilities themselves, contract farmers provide the raw milk which is processed into dairy products. This business model allows for quick adjustment to market conditions and prices. I have not explored how much hedging and how far into the future Kroger does, but I am sure that they do some forward pricing contracts. Hope this clears things up sufficiently.

Sep 21 02:48 AM