The Trouble With Kroger

| About: Kroger Co. (KR)

Summary

Kroger has done nothing over the last year.

The company is well-run and made a good acquisition in Roundy's.

Fashions change, and grocers are out of favor.

The trouble with Kroger (NYSE:KR) is that there is no obvious trouble with it.

The company is doing well. Its quarterly report for the period ending in January showed sales up nearly 4% from a year earlier, to $26.165 billion. Profits were up nearly 8% from the previous January, at $559 million. The analysts are happy bunnies, with 17 of 25 having a "buy" rating on the stock. CEO Rodney McMullen is a Kroger lifer and well-respected in the industry.

Yet over the last year Kroger shares have gone almost nowhere, up just 2%. Since executing a 2:1 stock split in June they're actually down slightly.

The stock carries a Price/Earnings multiple of nearly 18 and, while the dividend is covered nearly six times by earnings, it's just 11 cents for a yield of 1.15%. That dividend may be due for a bump after the April earnings come out, on June 16, at which time the earnings whisper is for earnings of 69 cents per share on revenue of $34.8 billion.

Kroger completed buying Roundy's, a Midwestern chain, for $800 million late last year (plus $600 million in debt), which sent the stock down. That deal came at the end of a long winning streak during the stock, which began at the end of 2012 with the shares at a split-adjusted $13 and topped out in December at $42.46.

So, you can make the argument it is taking time to absorb Roundy's, which included southeast Wisconsin's largest chain, Pick 'N Save. The focus in the deal, however, is Chicago's Mariano's chain, named for Roundy's CEO Bob Mariano, 66.

Mariano launched his eponymous chain in 2010, expanding it dramatically in 2013 when Dominick's, which he had been with most of his working life, closed. His plan is to eventually have 50 Mariano's in the Chicago area. It should be a good deal, getting Kroger deeper into prepared foods and gourmet items against Whole Foods (NASDAQ:WFM).

The closest thing to a hint I can find turns out to be the action in WFM itself, which has been on a downward slide since early last year, and has actually lost 40% of its value since then despite increasing the dividend and continuing to grow. (Kroger has debt on about one-third its assets, Whole Foods about one-sixth, all of it capital lease obligations.)

I personally picked up some Kroger last March, calling it "better than Costco (NASDAQ:COST)." But over the last year Costco hasn't been a world-beater, up just 6%, and Kroger had been matching that performance until last week.

My conclusion is that grocery chains are just unfashionable in the current market. Publix (OTC:PUSH) has a P/E multiple of 8, SuperValu (NYSE:SVU) is at 9. It's hard to call Kroger undervalued - the P/E is near the market multiple - but the premium it previously enjoyed has disappeared as investors have sought more risk and sexy tech plays. Tastes, however, will change, and when they do you may be glad to have a little Kroger in your basket.

Disclosure: I am/we are long KR, COST.

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.

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