Kroger - Steady As She Goes

| About: Kroger Co. (KR)

Shares of Kroger (NYSE:KR) are set to re-test their all time highs after the retailer reported its second quarter results.

There was nothing spectacular in the earnings report, except that Kroger continues to balance the demands from all its stakeholders in a good way. I continue to like the appeal of the giant, even after witnessing 50% year to date results, anticipating shares to set fresh highs in the remainder of the year.

It goes without saying that while shares still offer appeal, investors should not expect spectacular short term returns given the recent strong momentum.

Second Quarter Results

Kroger generated second quarter revenues of $22.72 billion, up 4.6% on the year before. Revenues came in line with consensus estimates of $22.71 billion.

The company reported a net profit of $317 million, up 13.6% on the year before. Diluted earnings per share rose by 17.6% to $0.60 per share, thereby coming in exactly in line with consensus estimates.

CEO and Chairman David B. Dillon commented on the second quarter performance, "Kroger's strong second quarter results have us on target to deliver the earnings per share growth we promised for the year. As we have shown quarter after quarter, our consistent execution of the Customer 1st Strategy deepens customer loyalty, increases sales and creates sustainable shareholder value."

Looking Into The Results..

While total sales grew by 4.6%, excluding the impact of volatile fuel sales, revenues were up by 3.9%. Excluding fuel sales, identical sales rose by 3.3% on the year before. Kroger saw an increase in traffic, partially offset by fewer items purchased per shopping trip.

FIFO gross margins, as calculated by Kroger came in at 20.46%, down 11 basis points from the year before, excluding fuel operations. The company took $13 million in LIFO charges compared to a $35 million charge in the comparable period last year.

Operating, general & administrative costs, excluding fuel operations, fell by 17 basis points as a result of strong sales leverage.

As a result, operating margins inched up a little bit to 2.6% as net margins improved to 1.4% of total sales.

..And The Remainder Of The Year

The company sees full year earnings of $2.73 to $2.80 per share, being consistent with its long term earnings growth rate of 8 to 11%.

The company narrowed the growth target for identical sales, excluding fuel to 3.0 to 3.5%. This compares to a previous guidance of 2.5 to 3.5% growth.

Valuation

Kroger ended the second quarter with $440 million in cash, and short term investments. Total debt, including capital lease obligations, stood at $7.89 billion, for a net debt position of almost $7.5 billion.

Revenues for the first six months of the year came in at $52.8 billion, up 3.9% on the year before. Net earnings rose by 11.1% to $798 million, as earnings per share rose by 18.5% to $1.54 per share. At this pace revenues could come in above $100 billion, while earnings could come in at $1.4-$1.5 billion.

Trading around $39 per share, the market values Kroger at $20.1 billion. This values operating assets at 0.2 times annual revenues and 14 times annual earnings.

Kroger pays a quarterly dividend of $0.15 per share, or an annual dividend yield of 1.5%.

Some Historical Perspective

For most of the past decade an investment in Kroger was pretty much dead money. As recent as November of last year, shares crossed the $25 mark towards the upside, seeing returns of over 50% ever since.

Between 2009 and 2012, Kroger has grown its annual revenues by a cumulative 26% to $96.8 billion. Net earnings have grown from break-even results to $1.5 billion in the meantime, as earning per shave have seen an additional boost as the company retired a fifth of its share base.

Investment Thesis

Kroger continues its impressive path to create shareholder value. A combination of solid sales growth, margin expansion, share repurchases, acquisitions and dividend hikes are the main reason behind the solid returns in recent times. Note that the repurchase activity has slowed down a bit as Kroger manages to keep leverage in check given the acquisition of Harris Teeter.

Kroger continues to focus on execution and customer loyalty to keep driving shareholder value. It is not just customers and shareholders for which Kroger is creating value, its associates are doing relatively well. Their compensation is above average, as the company furthermore spends $1.5 billion on healthcare for its associates. Many workers in this industry have to do without any benefits at all, making Kroger quite a generous employer. The job security and continued success of the company has allowed Kroger to add 33,000 jobs over the past five years.

Back in July, the company announced the $2.5 billion acquisition of Harris Teeter Supermarkets. The deal made sure that Kroger would surpass the $100 billion revenue mark for the year, as the company needs to grow operations to continue to compete with giants like Costco Wholesale (NASDAQ:COST) and Wal-Mart (NYSE:WMT).

At the time, I took a look at the company's prospects following the acquisition of Harris Teeter. Shares have risen some 5% ever since Kroger became a $100 billion company. Investors were applauding management for making the deal, in its attempt to continue to gain market share and become a formidable competitor of Wal-Mart over time.

Kroger remains on the right path in balancing operational growth, shareholder gifts and benefits for all other stakeholders. At the time I concluded that shares would need some time to consolidate before approaching the $40 per share level.

Today I continue to like the company's appeal with shares just trading a hair from $40. A sleeping giant which has boosted operational excellence and shareholder returns in recent years, has definitely awoken. I continue to like the long term appeal of the company, expecting the company to trade above $40 in the remainder of the year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.