Waiting On A Kroger Pullback

| About: Kroger Co. (KR)

Summary

Even after Wal-Mart's strong run-up this year, its earnings multiple is still lower than Kroger.

There is a nice bit of growth priced into Kroger stock. We need to reset sentiment and expectations.

The S&P 500 is due to roll over in the next month or so. This could be the catalyst for Kroger to trade in the 20's.

Wal-Mart (NYSE:WMT) stock has substantially outperformed Kroger (NYSE:KR) this year with the former up 16%+ year to date whereas Kroger is down 17.6% (see chart). Kroger came out with its fiscal first quarter earnings last week and although the company produced a beat on the bottom line, sales came in a bit light. As a result, the stock didn't gain any traction despite reporting a 13 basis point increase in its operating margin metric to 3.5%. We are holding Wal-Mart in our portfolio and this position has worked very well for us indeed although it has had quite a run-up in its share price recently. The question I want to raise in this article is this. Is there room for another retailer in our portfolio? Does Kroger's recent sluggish share price performance give investors an opportunity to start scaling into a position? Let's discuss..

If we put Wal-Mart up against Kroger and study their valuation metrics and financials, here is what things would look like..

Kroger Wal-Mart
Price To Book 4.9 3.0
Price To Sales 0.3 0.5
Dividend 1.2% 2.8%
Price To Earnings 16.6 15.8
Earnings Growth 8.74% -4.75%
Revenue Growth 3.8% 0.94%
Debt To Equity Ratio 1.42% 0.58%

The stats illustrate that Kroger is slightly more expensive than Wal-Mart but Kroger is growing its revenues and earnings much quicker than Wal-Mart. Furthermore Kroger has a lower dividend than Wal-Mart and less equity when reflected against its interest bearing debt. This means a true value investor would wait for Kroger's share price to fall further before entertaining the idea of going long. To some this defies logic when you consider that Kroger is predicted to grow its top line by well over 5% this year and next. Wal-Mart on the contrary is not expected to reach an annual growth rate level of 1% this year.

This is the problem with forward looking expectations. Kroger has already made its bed with its growth rates. Furthermore to compound the issue in the near term, next quarter could be rough as only an improvement of $0.01 is predicted in EPS over the same quarter in fiscal 2016. In the second quarter of 2016, Kroger reported a 26% hike in earnings per share which was a bumper quarter for the retailer which means to solely break even when the company announces its next set of earnings would be a solid performance in my view but the market may not take it the same way.

Kroger would really interest me around the $30 level. With a forward price to earnings ratio of 15.6, a share price of $30 would bring down this earnings multiple to 13.51 which would be two basis points below Wal-Mart's and 4 basis points below the Industry average of 17.6. Is there a possibility of Kroger dropping more than 4 handles?. I think it's not probable but if the S&P 500 (NYSEARCA:SPY) were undergoing a steep intermediate decline in the forthcoming months, it might just put enough pressure on an out of favor stock like Kroger.

So here is what you watch. I'm expecting the stock market to print an intermediate high within the next 4 to 6 weeks - max. Sentiment still hasn't reach ultra optimistic levels. We need to get sentiment above the 80 mark for the market to turn. Kroger has performed very poorly this year considering the breadth of the rally we have had in equity markets since February. Therefore once the market turns over, Kroger may fall more than many are currently predicting, in my opinion, which I believe would present a buying opportunity.

Source : Sentimentrader.com

I have always liked Kroger because of its consumer analytics and this is why I believe its Click-list & Express Lane initiatives will prove very successful. Furthermore, expect private label penetration to continue, which ultimately should keep operating margins growing over time. We just need to reset expectations a bit in this stock and a nice steep decline in the S&P 500 shortly might very well do it.

To sum up, I'm going to be adding a few good dividend and growth stocks to the Elevation Portfolio over the next several weeks, when I see value. In order to ensure that income is brought in every month, it's imperative that they are not correlated and all don't have similar valuations. You can follow along by pressing the "Follow" button above.

Disclosure: I/we 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.