Kroger (NYSE:KR) reported a somewhat disappointing fourth quarter on March 2nd. The company's 14+ year streak of quarterly identical store sales growth ended and earnings guidance for the current fiscal year was identical to the previous fiscal year (management foresees minimal growth).
In the paragraphs below I look at two possible interpretations of Kroger's earnings release. The positive interpretation focuses on long term growth and why Kroger may be currently undervalued. The negative interpretation focuses on why Kroger's past performance may no longer continue. I find this process of examining negative and positive views of an investment useful in deciding whether or not to initiate, close or continue a position. I'll conclude with my own outlook on Kroger.
All data referenced below is from the official earnings release.
Identical Sales and Competitive Pressure
For the first time in 52 consecutive quarters, Kroger reported a decline in identical store sales growth (-0.7%). The decline in comparable sales was driven by food price deflation, store relocations, and a stronger competitive environment.
The negative interpretation of Kroger's fourth quarter says the company will not be able to outperform competitors in the future.
- Wal-Mart and Target (NYSE:TGT) both announced they will invest to lower prices for packaged goods and groceries.
- German discounter Lidl is entering the US and will have stores open in Virginia by year end.
- Aldi's is investing $1.65 billion to expand its presence in the US.
Since Kroger's decline in comparable sales growth was partly due to stronger competition, its future prospects may be bleak. Lower prices from giants Wal-Mart and Target as well as increases in store count for Lidl and Aldi's will further pressure Kroger's future profit potential.
Market Share, Households and Corporate Brands
The paragraph above was a negative interpretation of Kroger's Q4 earnings release. This paragraph is a positive interpretation.
For the 12th straight year, Kroger increased market share. This increase includes existing store growth as well as the impact of acquisitions (most recently Roundy's and Hiller's). Market share growth also includes stores that were relocated less than 1 year ago which are not a part of comparable sales growth.
In fiscal year 2016, corporate brands or private labels, accounted for 29% of total volume (ex fuel, ex pharmacy). Sales of private label products have higher gross margins than sales of name brands. If Kroger can continue increasing private label sales, the company's profitability will improve in the future.
In Q4 and fiscal year 2016, loyal households grew at a faster rate than total households. Comparable sales for loyal households, including price deflation, were slightly positive. Kroger is growing its loyal customer faster than its overall customer base and loyal customers are spending more.
The positive interpretation of Kroger Q4 earnings release shows the company continues to get a larger portion of the grocery retail market (market share), increase its gross margin (corporate brand performance) and is increasing its loyal household count (which had positive identical sales growth). A continuation of these trends points to a brighter future for Kroger.
Long Term Investors Take
I have been a Kroger investor for quite a few years now. With the recent decline in share price, I'm down a few percent points but plan to keep my position.
As a long term investor, I view the company's continued growth in corporate brand sales and loyal households as key indicators of future profitability.
Simple Truth launched 2011 and is now generating over $1.5 billion in annual sales with minimal advertising. Hemisfares and the recently acquired Murray's Cheese may also grow into large corporate brands.
Loyal customers are the bread and butter for any business. Kroger's continued growth in loyal households shows the company understands its customer and customers enjoy shopping at its stores.
In conclusion, there are positive and negative interpretations to Kroger's Q4 earnings release. The negative interpretation says that increased competitive pressure in pricing from Wal-Mart and Target may lead to slower comparable store sales growth. Expansion of hard discounters Aldi's and Lidl will also pressure future growth. The positive interpretation say continued increases in market share, loyal households and corporate brand sales may lead to increased future profits.
Over a long time horizon, I think Kroger will outperform its peers and am keeping my long position in the company.
Disclosure: I am/we are long KR.
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.