Kroger's vs. Whole Foods: Buy Low, Sell High

Includes: AMZN, KR
by: Mark Krieger

As far as the market is concerned, WFMI is the glamorous, sexy, momentum stock while Kroger's (NYSE:KR) motif is more in the realm of the boring, stodgy and forgetful. As a matter of fact, WFMI's shares nearly doubled in 2010 (up about 88%), while KR's stock managed to muster a feeble 5% gain, despite the DJIA having one of its best years on record, climbing in excess of 13%.

There is no doubt the dichotomy between KR's poor relative strength and WFMI's very high relative strength was off the charts, but this phenomenon creates opportunity, as KR can still be purchased at a bargain price while WFMI can be sold at a level priced for perfection and then some. After all, how else are you supposed to be able to buy low and sell high if you don't buy stocks when they are unpopular, and sell them when they are popular?

Although KR sells more groceries than any other competitor in its space (traditional supermarkets), WFMI sells more groceries in its segment (high end supermarkets). In 2012, KR is expected to earn $1.92, and oddly enough, so is WFMI. KR pays an annual cash dividend of 42 cents (1.90% yield) while WFMI’s payout is eerily close at 40 cents (.80% yield).

WFMI’s market cap of $8.96 billion, is not that far off from KR’s current market value of $13.71 billion. KR’s forecasted earnings growth in 2012 of 9.7% is only a tad lower than WFMI’s anticipated 12.2% gain, but this is where the similarities come to a crashing halt, as one operator stands out as the clear investment choice.

Black and white: If you analyze these two companies on an absolute basis, rather than a per share basis, their differences become glaring. For example, KR is expected to generate revenues of $85 billion, dwarfing WFMI’s sales of $11 billion by nearly a factor of eight times. KR’s earnings of $1.22 billion just about quadruples WFMI’s earnings of $332 million. KR’s annual cash dividends of $267 million appear behemoth to the $69 million worth of checks cut to WFMI shareholders.

The coupe de grace: The market is giving WFMI a forward multiple of 27, and KR an unloved multiple of 11. Why is the market valuing WFMI at roughly 2.45 times higher than KR? Could it be due to WFMI’s superior earnings growth rate (it’s about 24% higher)? If you do the math on that one, it would calculate to a WFMI forward multiple of about 14 (1.24 x 11) so that can’t be the answer. The only obvious answer: Wall Street is speculating that KR’s estimates are way too high, and WFMI’s are way too low, but I think the market is wrong.

The favoritism can’t last forever, as the markets are extremely fickle. I would not be surprised to see the spreads between the two companies' multiples contract in the next year by as much as 50% (from a delta of 16 to 8), with WFMI’s multiple possibly dropping to the 22 vicinity, while a rise in KR’s popularity could translate to a multiple closer to the 14-15 range.

Bottom line: KR should rally 33% on the year to the $28 level (about 12% higher than the median analyst estimate of $25) while WFMI's median analyst one year target of $49 is already 5% below its current share price. Under my analysis, (utilizing a more realistic 22 multiple) WFMI's median target price is still too high and should be nearer to the $42 level. It is time to buy KR wholesale, and sell WFMI retail.

Disclosure: I am long KR.