Major Grocers Growing Sales But Not Clean Stories

Includes: AMZN, KR, SVU
by: Valuentum


Major grocers reported solid top-line results in their most recent quarterly results.

But between overleveraged balance sheets and public relations nightmares, there are not many clean ideas.

Asparagus water, anyone?

By Kris Rosemann

Firms in the mature food retailers industry generally have slim profit margins and face significant competition from brick-and-mortar locations (discount, department, drug, dollar, warehouse clubs and supermarkets) as well as Internet-based retailers--including Amazon (NASDAQ:AMZN). Though the industry is not terribly cyclical, economic conditions, disposable income, credit availability, fuel prices, and unemployment levels drive ticket size and traffic trends. Offering consumers a compelling value proposition is a must, even as higher-priced organic food offerings proliferate.

The national average for gas prices are over $1 lower than at this time a year ago, according to reports, though places in the Midwest continue to feel the pinch at the pump from a key refinery shutdown in Indiana. Other economic conditions have been relatively favorable, with unemployment rates reaching the lowest level since early 2008 and job openings approaching all-time highs. These and other factors have helped Kroger (NYSE:KR), SuperValu (NYSE:SVU), and Whole Foods Market (WFM) to top-line growth in their most recently reported quarters, and cost controls continue to be a key driver behind earnings leverage across the group.

Let's take a closer look at the quarterly performance of each of these three major grocers.

Kroger Has Reported Nearly 50 Consecutive Quarters of Same Store Growth

Kroger's recently reported results for the quarter ended August 1 caught the attention of investors, as its shares rallied following its release September 11. The company reported identical supermarket sales excluding fuel growth of over 5%; the quarter represents Kroger's 47th consecutive quarter of identical supermarket sales, excluding fuel, growth. Including fuel sales, the identical supermarket sales grew at a much more modest rate of 1.3%, a direct result of lower gasoline prices compared with the year-ago period.

Kroger reported net earnings of $433 million, or $0.44 per share, representing nearly 25% growth compared to the second quarter of fiscal 2014. Management cited its ability to leverage operating expenses due to strong cost controls and improving fuel margins as drivers for this significant pace of earnings expansion. The outstanding results led the company to raise its guidance for earnings per share for the full fiscal year. It is now expecting net earnings per diluted share in a range of $1.92-$1.98, compared to the previous guidance range of $1.90-$1.95. Kroger also raised its full-year expectations for identical supermarket sales growth from a range of 3.5%-4.5% to 4%-5%.

Without a doubt, Kroger is executing at a very high level. However, we'd prefer the company have a stronger balance sheet. It has only $268 million in cash on the books, compared to current debt over $1.5 billion and long-term debt of nearly $10 billion. Even though Kroger sports an investment-grade credit rating supported by a manageable net debt to adjusted EBITDA ratio of ~2, in the context of other ideas, we're not fans of this kind of leverage in such a competitive environment. Kroger yields just north of 1%.

SuperValu Slowly Improving

SuperValu reported its first quarter of fiscal 2016 results, ended June 20, in late July. The firm experienced revenue growth of 2.7% to $5.41 billion, and it leveraged such growth into operating earnings expansion of ~17% to $158 million compared to the year-ago period. The strong pace of earnings growth was driven by the increase in sales, as well as an improved gross margin--which advanced 60 basis points compared to the first quarter of fiscal 2015--and lower logistics costs. Management is confident in its ability to continue to effectively manage costs, even in an environment where sales growth wanes. Net earnings from continuing operations advanced from $0.18 in the prior-year period to $0.23 in the quarter.

SuperValu's cash from continuing operations more than doubled compared to the year-ago period, to $111 million. However, the company will need to string together several quarters of this type of cash flow generation to return to stable, financial ground as its debt-load far outweighs its cash position. Unlike Kroger, SuperValu's credit rating is junk status, and as of the end of the quarter, the firm had $2.2 billion in long-term debt compared to just $137 million in cash and equivalents. Though both of these measures have improved from the same time a year ago, SuperValu has a history of cash-flow mismanagement, as it was forced to suspend its dividend in 2012 in order to lower prices to compete with other grocers.

SuperValu is planning to spin off its discount grocery store chain Save-A-Lot into a standalone public company. The firm believes this move will unlock additional value for its Save-A-Lot brand and its independent and retail food businesses; the separation would allow for greater management focus at each of the business units, with greater flexibility for each business to pursue its best interests while having a more focused allocation of capital investment. We generally like the potential move, though it is not likely to happen until sometime in 2016 at the earliest.

Whole Foods Market Experiences Slow Organic Growth

Whole Foods Market reported the results of its fiscal 2015 third quarter, ended July 5, on July 29. The firm realized record quarterly revenue of $3.6 billion, or growth of 8%. Comparable store sales grew 1.3% on a constant currency basis. Operating income was relatively flat at $247 million compared to the year-ago period, as the cost of goods sold advanced at a higher pace than sales.

Free cash flow fell from $77 million in the comparable period of fiscal 2014 to $67 in the third quarter of fiscal 2015 due to increased capital expenditures. The deteriorating cash-flow generation isn't as concerning, however, as Whole Foods has a relatively strong balance sheet. It has essentially no long-term debt, which compares to over $800 million in cash, equivalents, and short-term investments on the books.

Whole Foods may very well need this financial flexibility in the near future, as it continues to navigate a series of public relations obstacles. New York City inspectors uncovered what they described to be "the worst case of overcharging" they had ever witnessed, where Whole Foods charged too much on weight-based pricing due to inaccurate labeling. Whole Foods has broken its trust with consumers, and many are flocking to the web to mock the company's products, the latest in regards to asparagus water.

For the full fiscal year of 2015, Whole foods is expecting sales growth of approximately 9%, driven by the opening of 38 new stores and boosted by comparable store sales growth in the low-single digits. It is projecting EBITDA to be ~9% of sales, which it surpassed in its fiscal third quarter with $353 million in EBITDA, or 9.7% of sales.

Wrapping Things Up

Though the top-line growth of each of these food retailers has been solid, we find issues with each of them as investment ideas. Kroger and SuperValu have significant financial leverage that we are not fond of, and SuperValu has a history of cash-flow mismanagement; we don't think investors will ever forget the suspension of its payout in 2012. Whole Foods has a much healthier balance sheet, but with the current public relations headwinds it is facing, we would like to see some traction in a recovery before considering it as an investment idea. On an operational standpoint, however, Kroger stands head-and-shoulders above its peers, in our view.

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.