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The Kroger Co. (NYSE:KR) is the nation's #1 pure grocery chain, but it still watches out for falling prices; Wal-Mart (NYSE:WMT) has overtaken Kroger as the largest seller of groceries in the US. While Kroger has diversified through acquisitions, adding jewelry and general merchandise to its mix, food stores still account for about 85% of sales.

The company operates about 3,650 stores, including nearly 2,470 supermarkets and multi-department stores, under two dozen banners in 31 states. It also runs about 780 convenience stores under names such as Quik Stop and Kwik Shop. Kroger's Fred Meyer Stores subsidiary operates more than 120 supercenters, which offer groceries, general merchandise and jewelry in the western US.

The Kroger Company sold $66.11 billion worth of groceries and other items last year. This year, analysts think the total will be $68.5 billion, and next year $71.5 billion. Earnings have fared even better; in 2004, they were $1.03 per share, in 2005, $1.31, and earnings were $1.54 in 2006. This year, expect $1.65 and $1.84 next year. According to predictions, revenues will grow by 6.5% a year on average for the next 5 years while earnings will move ahead by 11.5% on average. A negotiated wage contract with its union helped earnings this year. In 2004, there was a work stoppage and protracted talks before an agreement was reached. This year, the talks went on without a work interruption.

Kroger has been increasing sales at a better than 3% clip in the last 8 quarters with a 5% gain in the most recent quarter. This is in contrast to the quarterly decline reported earlier in the decade as super stores such as Wal-Mart and Whole Foods chains entered the competition for the grocery dollar. Recently Wal-Mart announced it will be slowing its openings of supercenters as it recalculates the benefits of going head to head with grocery giants such as Kroger. Look for a new entry in the field soon; Tesco, the largest food retailer in England, announced plans to enter the U.S. market later in 2007. It operates much like Wal-Mart, and is a supermarket and convenience store combined into a super store.

Back to Kroger, current liabilities are greater than current assets by about 1.2 times. Debt is 50% of the balance sheet. Net profit margin is 1.7% and should slowly improve to 2.1% over the next 5 years as non-grocery items contribute to margins. There is a small dividend that yields 1.1% for now, but with good cash flow, it may be raised again, as it was this year from 26 cents a share to 30 cents a share. Dividends only require 18% of net profits. There are 710 million shares (715 million fully diluted), which put the market cap at almost $20 billion.

Kroger has turned things around. It's broadening its sales base, taking on Wal-Mart at its own game and winning. This is a different Kroger from the late 90s, when the stock went from $34.90 to $14.90 in one year (split adjusted). The stock is off its recent high of $31.90 by about 20%. If it delivers the earnings as predicted, buys back more shares as well as more debt, and holds its own against Tesco, Kroger may come out the champ in the battle among the mega stores.

KR 1-yr chart:
KR 1-year

Source: Kroger May Win the Mega-Store Battle