Kroger's 40% Upside Tops Safeway, Supervalu

Jan.30.12 | About: Kroger Co. (KR)

The Street currently rates shares of Safeway (NYSE:SWY) and Supervalu (NYSE:SVU) closer to a "sell" and shares of Korger (NYSE:KR) a "buy". In general, while I also prefer Kroger, I am considerably more bullish versus consensus on Safeway and Supervalu based on my multiples analysis and DCF model.

From a multiples perspective, Supervalu is the the cheapest of the three. It trades at 5.7x forward earnings and has by far the highest dividend yield at 4$. In comparison, Kroger trades at a respective 12.5x and 11x past and forward earnings while Safeway trades at a respective 15.2x and 12.3x past and forward earnings. These two companies are also less volatile than the broader market as opposed to Supervalu, which is 20% more volatile than the broader market.

At the third quarter earnings call, Kroger's Chairman & CEO, Dave Dillon, noted stellar performance:

"Kroger associates delivered on our Customer 1st strategy in the third quarter. We had strong sales and earnings per share growth. This is exactly the positive momentum we strive for as we enter the holiday season, our most exciting time of the year, and we are very pleased.

Keep in mind that a year ago, third quarter earnings were helped by a $0.02 tax benefit and a $50 million lower LIFO charge. In that context, this was an outstanding quarter".

Management is getting more aggressive on returning free cash flow to shareholders, which suggests confidence in supportive operational performance. During the third quarter, the company solidly beat consensus with an EPS of $0.33. It recently issued $450M worth of 5-year notes with a 2.2% coupon - which indicates that the market assesses it is as less risky than Supervalu. Amidst restructuring efforts and greater average transaction size, Supervalu had a 2.9% decline in identical same store sales.

With Supervalu struggling and the Food Lion closing in Georgia, Tennessee, Kentucky, and Virgina, Kroger is well positioned to gain market share. Positive earnings are flowing smoothly from operating leverage.

Consensus estimates for Kroger's EPS forecast that it will grow by 13.6% to $2 in 2012 and then by 11% and 7.7% in the following two years. Assuming a multiple of 15.5x and a conservative 2013 EPS of $2.19, the rough intrinsic value of the stock is $33.95, implying 39.7% upside. Supervalu's EPS, on the other hand is forecasted to decline by 11.5% to $1.24 in 2012, hold flat in 2013, and then grow by 11.4% in 2014.

Safeway, just like, Supervalu is also viewed as risky on the Street. But increasingly aggressive buyback activity - such as a 90% increase to the repurchasing program - and the closing of underperforming stores suggests confidence in improved efficiency. Third quarter results were further above both external and internal expectations as EPS grew 15% from a year ago to $0.38. Divesting Burnaby for $100M will further improve efficiency. Just like how Supervalu had solid progress in the third quarter, Safeway also indicated solid momentum with sequential growth in ID sales.

Consensus estimates for Safeway's EPS forecast that it will grow by 11% to $1.72 in 2011 and then by 6.4% and 7.7% more in the following two years. Assuming a multiple of 15.5x and a conservative 2012 EPS of $1.78, the rough intrinsic value of the stock is $27.59, implying 22.3% upside. Modeling a CAGR of 8.3% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $25.18, implying that Safeway is safer than what the Street suggests.

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