Kroger - Great Performance, Limited Appeal After A Very Strong Performance Already

Jun.20.14 | About: Kroger Co. (KR)


Kroger continues to report very strong identical sales numbers in a competitive market.

The Harris Teeter acquisition has worked out well.

After the huge run-up over the past year, the immediate appeal is limited.

Kroger (NYSE:KR) continues to report rock-solid results. After the first very strong quarter, it feels already comfortably enough to raise the full year guidance as the acquisition of Harris Teeter and strong operational performance is driving growth.

While I continue to applaud the great operational achievements, shares have seen very strong momentum already, trading up more than 40% over the past year. That and the increased valuation is a bit aggressive for a supermarket chain, making me cautious at current levels.

First Quarter Highlights

Kroger reported first quarter revenues of $32.96 billion, up 9.9% compared to last year, driven by the contribution from the Harris Teeter acquisition.

Reported net earnings were up by 4.2% to $501 million as modest share repurchases pushed up earnings per share growth with diluted earnings increasing by six cents to $0.98 per share.

Adjusted earnings of $1.09 per share came in four cents ahead of consensus estimates.

Looking Into The Results

Sales were driven by a very impressive 4.2% increase in identical sales. Excluding fuel sales, identical sales would have grown even 0.4% faster. This quarter was the 42nd consecutive quarter of positive identical supermarket sales growth, which is a very strong achievement by all accounts.

Kroger managed to boost gross margins by 30 basis points to 20.9% of sales. These margin gains were offset by operating expenses, which were up by 40 basis points to 15.7% of sales. Higher expenses were related to one-time restructuring of pension agreements, and would have been down by 0.1% excluding this factor.

As a result, operating earnings were down 10 basis points to 2.8% of sales, resulting in very slim margins. Net earnings came in at just 1.5% of sales.

Adjusted earnings came in at $1.09 per share versus reported earnings of $0.98 per share. The restructuring of certain pension obligations explains the difference between GAAP and non-GAAP earnings.

Raising The Guidance

On the back of the very strong results, Kroger has raised its full year guidance from $3.14-$3.25 per share towards $3.19 to $3.27 per share.

The company is guiding for a rather aggressive 8-11% growth in long-term net earnings per diluted share. Identical supermarket sales are up 3 to 4% for the year, which implies that Kroger has raised the range by 50 basis points.

Valuing Kroger

The company ended its first quarter with $265 million in cash and equivalents. Total debt and capital lease obligations rose, due to the Harris Teeter deal, and came in at $11.22 billion. This results in a net debt position of roughly $11 billion.

Given the outlook, Annual revenues of $108-$109 billion are attainable with diluted GAAP earnings are seen around $3 per share.

Trading at $50 per share, Kroger is valued at $25.5 billion. This values the company's equity at roughly 0.25 times revenues and 16-17 times GAAP earnings.

Kroger's quarterly dividend of $0.165 per share provides investors with a 1.3% dividend yield.

Slightly Constrained

The impact of share repurchases and the Harris Teeter acquisition has driven up leverage over the past year. The net debt/adjusted EBITDA ratio has risen to 2.42 from 1.85 last year. The company still targets a 2.00-2.20 ratio by the middle or late 2015.

Note that debt already rose on the back of the deal, while the deal closed later which resulted in Kroger not being able to ¨count¨ EBITDA generated by Harris Teeter for some time. As such, the ratio should already approach the higher end later this year.

Kroger felt comfortable enough to repurchase 25.7 million shares for $1.1 billion during the quarter. This is a great investment given that this results in an average price of $42.80 per share.


Kroger's shares have been on a winning streak, gaining more than 25% so far this year in a very competitive marketplace. The $2.5 billion acquisition of Harris Teeter Supermarkets which closed in January, contributed for the first time to a full quarter's results.

With the acquisition, Kroger added another 200 supermarkets in order to achieve even more scale to compete with the likes of Wal-Mart (NYSE:WMT) and Whole Foods Market (NASDAQ:WFM), among others. On the back of the acquisition, Kroger now has some 2,642 supermarkets while employing a dazzling 375,000 workers.

Over the past decade, Kroger managed to roughly double its annual revenues to an anticipated $108-$109 billion this year. Earnings have grown less quick, increasing from roughly $1 billion to $1.5 billion over the same time period amidst margin pressure. Earnings per share growth was solid as the company retired roughly a third of its shares over this time period.

Continued and steady growth was finally rewarded as shares have mostly traded in a $20-$30 trading range until shares broke out early in 2013. From that moment on, shares have risen to highs of $50 at the moment. The commitment to 8-11% long-term earnings growth and cash returns to investors is very appealing to investors in this environment.

Back in September of last year, I last checked out the prospects of Kroger when shares were still trading around $40. I concluded that Kroger was on the right path of balancing growth and shareholder payouts. Furthermore, the "sleeping giant" has boosted its operational excellence, something which finally was rewarded last year.

Ever since shares have risen by another quarter, and while I remain upbeat about the long-term prospects, I am much more cautious now after the recent strong momentum.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.