Shares Of Kroger Are Riding The Bull - Is It Time To Check Out?

| About: Kroger Co. (KR)

Despite competing in an intense industry where margins are razor-thin, The Kroger Co. (NYSE:KR) has emerged as a market leader. Shareholders have been rewarded handsomely with a stock price that is up 76% over the last three years. Kroger's closest competitors, Safeway (NYSE:SWY) and Wal-Mart Stores (NYSE:WMT) are up 32% and 40%, respectively. Only Whole Foods Market (NASDAQ:WFM) has outperformed over the last three years, up 188%.

I first wrote favorably about Kroger in 2010 and subsequently made it one of my best picks for 2011. Shares at that time traded in the $21-$22 range. Kroger now trades at $36.60, off its 52-week high of nearly $40.

Kroger, based in Cincinnati, OH, is the nation's largest supermarket chain. It operates over 2,400 supermarkets and multi-department stores under many different banners. Kroger recently announced the purchase of Harris Teeter Supermarkets (NYSE:HTSI) and will operate its more than 200 stores under the Harris Teeter brand.

How is Kroger differentiating itself from competitors? The company implemented what it calls its Customer 1st strategy several years ago. Since then customer loyalty has increased significantly. Kroger has successfully tied its fuel centers into its loyalty program, rewarding customers who shop at its stores with discounts on gasoline. Kroger renovated and redesigned many of its stores, giving them a more upscale look. The company added wine departments made to look and feel like a wine shop. It also added more upscale deli offerings as well as Sushi counters in many of its stores. Kroger has taken on a transformation that has it competing more with Whole Foods than with Wal-Mart. That's a smart choice by management since going head-to-head with Wal-Mart can be a difficult task. Kroger has also increased its natural and organic food offerings, even starting its own successful organic brand, Simple Truth. According to its most recent quarterly report, corporate brands, such as Simple Truth and Private Selections, accounted for 23.7% of sales dollars. Private label brands generally carry higher margins for grocery stores.

The latest quarter was Kroger's 38th consecutive quarter of increasing same-store sales. Due to the company's success and its leading position in the sector, management feels comfortable projecting a long-term earnings growth rate of 8%-11%.

"Our ability to achieve earnings per share growth of this magnitude puts Kroger in an exclusive class of companies capable of delivering this level of growth on a consistent basis."

-David Dillon, Chairman and CEO

Kroger plans to use its cash to fund stock buybacks and dividends as well as future capital investments. The company is using debt to purchase Harris Teeter. In the first fiscal quarter, Kroger repurchased $146 million in stock. Kroger's stock buyback authorization stands at $447 million. Management has stated that the stock is in an "attractive" range to continue buybacks. Kroger's dividend yields 1.64%.

With the stock up 73% since I first recommended Kroger, the question becomes "when do I take profits?" At that time Kroger was trading at only about 12 times earnings. Today, it's only trading at 12.6 times earnings, meaning almost all of the share price gains have come on the back of earnings per share growth. To put that into perspective, Whole Foods trades at 36.4 times earnings and only has a 13% earnings growth rate. Kroger can't be expected to grow earnings like it did coming out of the deep recession. However, management is predicting long-term earnings growth of 8%-11%. That alone would be a solid return. Factor in the dividend and Kroger should continue to be a solid company to own going forward.

I like to own shares in companies that are "best in class." I honestly believe Kroger fits into that category. As long as the broad economy stays stable, Kroger can keep gaining share. Investors who bought several years ago when the stock was depressed are sitting on solid gains. Consider taking some profits only if it makes sense, such as to rebalance a portfolio. In fact, I added to my position on this recent pullback from the 52-week high. The bottom line is - if you still have Kroger in your cart, don't head to the checkout yet.

Disclosure: I am long KR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Mr. Constantino is a proprietary investor and does not provide individual financial advice. The stocks mentioned in this article do not represent individual buy or sell recommendations and should not be viewed as such. Individual investors should consider speaking with a professional investment adviser before making any investment decisions.