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Kroger Stock Heading To Where It Belongs: The Low $20s

Mar. 08, 2018 1:01 PM ETThe Kroger Co. (KR)SPY72 Comments


  • Following a decent quarter and reasonable outlook, I believe Kroger's stock was ripe for a valuation pullback.
  • I continue to be cautious about Kroger's near-term performance, given the earnings sensitivity to even minor margin pressure.
  • While the grocery store chain is likely to do fine in the long run, I believe KR belongs in the low $20s range for now.

The results of Kroger's (NYSE:KR) 4Q17 were not too bad, and the outlook for 2018 was certainly not disastrous. Ordinarily, I would argue that a solid print should not have driven the bearish -10% stock price reaction in the early hours of Thursday's trading session. But following a six-month rush of 14% ahead of the broad market's (SPY) 11% returns, as of the end of last week, I believed KR was ripe for a valuation pullback.

Credit: Supermarket News

On the numbers

I argued earlier this week that, given strong peer performance across the food retail sector in the last quarter of 2017, Kroger was likely to deliver at least the 1.1% in identical sales set by the management team as the low end of its expectations. Excluding fuel, comps came in a bit better at 1.5%, helping to send total revenues $200 million above consensus.

See improved quarterly comps trend below.

Source: DM Martins Research, using data from company reports

Below the revenue line, however, GAAP gross margins (which include a LIFO credit of $54 million) dipped about 30 bps YOY to 21.9% after having improved 17 bps in 3Q17. Although not much more was shared in the press release regarding the deterioration, keeping profitability at healthy levels is crucial for Kroger to maintain its earnings power, given the company's razor-thin margins. Pricing pressure is an area of particular interest to me since any headwinds here would flow straight down to the bottom line.

Opex of $5.32 billion, adjusted for pension- and impairment-related charges, increased a somewhat concerning 18.6% YOY to account for 17.1% of total revenues vs. last year's 16.2%. It looks like the spike would have been less pronounced once fuel is excluded from the comparison. However, I estimate that non-GAAP EPS of $0.63 failed to beat consensus estimates despite strong revenues, in part, as a result of some loss

Note from the author: I do not own KR in my portfolio because I believe I can generate long-term growth with limited downside risk in a much more efficient way. This is why I built my Storm-Resistant Growth Portfolio. To learn more about it, click here and take advantage of the 14-day free trial.

This article was written by

DM Martins Research profile picture

Daniel Martins is a Napa, California-based analyst and founder of independent research firm DM Martins Research. The firm's work is centered around building more efficient, easily replicable portfolios that are properly risk-balanced for growth with less downside risk.

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Daniel is the founder and portfolio manager at DM Martins Capital Management LLC. He is a former equity research professional at FBR Capital Markets and Telsey Advisory in New York City and finance analyst at macro hedge fund Bridgewater Associates, where he developed most of his investment management skills earlier in his career. Daniel is also an equity research instructor for Wall Street Prep.

He holds an MBA in Financial Instruments and Markets from New York University's Stern School of Business.

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On Seeking Alpha, DM Martins Research partners with EPB Macro Research, and has collaborated with Risk Research, Inc.

DM Martins Research also manages a small team of writers and editors who publish content on several TheStreet.com channels, including Apple Maven (thestreet.com/apple) and Wall Street Memes (thestreet.com/memestocks).

Analyst’s 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.

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Comments (72)

Marty used to say, "don't fight the tape". I capitulated and bought 1 (one) share of AMZN. It is up 60% from when I considered it last November. Makes no sense, PE of 260, no dividend, no real barriers to entry of its areas of expertise. I have scads of KR, but it retreats at any hint from AMZN. Now, this is interesting!
16 Mar. 2018
I look at AMZN every quarter or so with serious intention to buy. Every quarter it seems ridiculously expensive and I say, "No. I don't see the steps to the 10x increase in earnings over the next few years that would make this price reasonable." And yet, every quarter the price keeps going up. This plot makes no sense to me: http://bit.ly/2Dy9ASG
Erik Neelsen profile picture
Looking for $19's
KR is on sale for me, filled at 23$. first time holding.
It's interesting one analysis with Seaking Alpha recommend Kroger the other bashes it!!!! Think they should get together to and agree on a recommendation!!!!!with
Bought in when the Amazon news broke for a steep discount, sold at $26, rinse and repeat...Good luck folks.
Trading was ugly on the 8th, I was watching for a partial recovery in the last hour back up to the 200ma and it never happened. Otherwise there's little support until about $20. I like the company's fundamentals just fine, but Mr. Market currently does not seem to share my views. That's fundamentals - the big threat to Kroger isn't Amazon or Walmart it's Trader Joe's and in the 18 years since I worked briefly for Ralphs markets, before Kroger even got them, the big guys have still not figured out what to do about TJs or how to emulate TJ's profitability - and meanwhile TJ's has improved immensely and with many more locations.

So, if the chart talks to me, and I'm at my keyboard in time to make a good trade I'd like to establish a modest position in KR, missed it six months ago on the Amazon dip (was waiting for another dip down, and it never did) and this looks like a nice second chance. But this two-day action was ugly, ugly.
Over the past year, Kroger has been an excellent trading stock.

The market is funny as Kroger posted YoY growth in same-store sales (ex fuel) and operating expenses were higher due to investment in staff, equipment and technology, something Kroger management said it would be doing.

Barring a major market correction, I believe the shares will be trading around $30 within a year.
DM Martins Research profile picture
"Excellent trading stock": that is true. It's interesting to see that KR trades today at about the same $23/share that it did when I published my first mildly bearish (let's call it "skeptical") piece on this stock in Sep 2017 -- but between then and now, the stock has been to heaven and back.

Who Dat 1 profile picture
The 6% two days ago followed by the 12% today has me saying overacting. Best of luck to all. Good company, good footprint geographically. Have sat on the fences during other downturns, not again.
KR was my good buddy last year...sold it a month ago as all I could see was 'gap fill' and oddly it started out today at the bottom of that gap. 18/sh didn't happen on the last series of panics so my bet is focus on event risk. It is starting to become clear to more people that Trump's technique is to throw a bunch of shit against a wall and see what sticks. Once the market adjusts for this, there won't be so many great opportunities the minute Amazon announces its next endeavor....take them while you can.

Anyone who bought major established companies last year threatened, or perceived to be threatened, by Amazon, could have done very well (look at TGT, that was nice from June to Feb, 50%). HD and UPS are also looking good for above average swings lately, particularly UPS.
during the last trip to the low 20's we sold puts, bought the stock sold calls in about four transactions and netted $3,900. This morning as the stock hit 23, we sold the July 21 strike for .98. The stock is fair priced to cheap here by numerous metrics: sales, profit, dividend payout.
I don't mind taking the premium alone or owning the stock, collecting the mediocre dividend and selling calls.
Erik Neelsen profile picture
Maybe sub $20 next week
raytoei profile picture
Thanks to author for article. I Always welcome another point of view.

I am Long on KR, and my 2 cents is that Mr. Market has been jittery this week and has offered us an opportunity to buy KR at a great price. A great company run by great management being sold off because of over expectations of threats and eps estimates.
nothing you said has anything to do with the fact that Kroger over promised on their numbers and under provided on their numbers...
As a whole food customer I can assure you there’s very little difference in the prices....... as far as the union goes- It’s just a matter of time before the public turns on Amazon and the unions come rushing in. Opinion always turns on companies making a huge profit paying low wages.
I too am a whole food customer and I can assure you that my whole foods has lowered many of their prices...as far as the union goes why haven't they turned on Wal-Mart if your theory is correct...
You don’t think the public has been critical of Walmart pay/treatment of employees?? Look back 2-3 years ago. Walmart was getting torched by its own employees/media and since worked hard to improve pay/benefits. Amazons day is coming....
I added some today. By many metrics, this is a $30 stock.
Agree with you, good time for an entry now and 6 months down the line or one good earnings report it is going to hit hit 20's
whole foods has lowered 30 percent of their prices and has just announced it is ramping up their delivery program to cities like Atlanta...Kroger is also heavily unionized which is an added burden..I bought it at 38 and dumped it at 28.44..Will be at 14 by the end of the year..there will be no good earnings reports..the sky isn't falling but there are a lot of thunderstorms...
forget now....what about the future?????
Thecult13 profile picture
Got nice cheap $23 calls for April can’t wait to see this thing do it’s bounce between now and then.
Dingwell88 profile picture
They are guiding for $1.95 - $2.15 EPS for the next year. KR is very good at hitting estimates, really good. Assuming that they get the consensus EPS of $2.10 and applying their 10 year normal PE of 14.2 puts the FV around $29.82. Sure that is just cigarette pack math, but saying that FV should be in the low 20s is asinine. A PE of 14-15 for a slow and steady company like KR is quite fair. Their fwd PE is 10.95 as of writing this ($23). That is almost 30% upside for one of the nation's largest grocers. If I were them I would be using some cash to buy back shares at these values.
This guy is clearly a day trader who lost his money trying to make a "quick" trade. Now he is simply trying to cover his losses and bash the stock. Seems like an amateur to me who is writing articles to hide his tantrum.
mjtroll1 profile picture
regarding this statement

This guy is clearly a day trader who lost his money trying to make a "quick" trade. Now he is simply trying to cover his losses and bash the stock. Seems like an amateur to me who is writing articles to hide his tantrum.

how is this clear?
DM Martins Research profile picture
I'm not really into day trading. I'm too cheap to pay trading fees and taxes on short-term capital gains. I actually turned fairly bearish on KR on Sep 6, 2017 (http://bit.ly/2G8xXcy), and only moved farther away from the stock since then. We're back at the same $23/share today.

Thanks for the note.
You have been wrong from Sept until now
"Ripe for a valuation pullback" on a stock with a really low valuation. This bubble's gonna burst...
DM Martins Research profile picture
"Really low" is a relative term. The November-February rush got way ahead of the earnings potential, I thought. We'll see what happens next.
Revenue and comps up, so not as bad as it seems. Yeah margins down but they are investing a lot. Lower margins is not a KR only problem. This will rebound back again to the high 20s soon. Also, if BABA wanted to but then, this is a great opportunity! Just bought some shares today taking advantage of the dip.
DM Martins Research profile picture
They're certainly still doing fine on sales. The margin, even if not unwinding, is what concerns me. Thanks.
Mitch Zeitz profile picture
"Also, if BABA wanted to but then, this is a great opportunity! Just bought some shares today taking advantage of the dip."

If Amazon is serious about groceries, they're going to have to buy Kroger.
08 Mar. 2018
Their transformation plan chewed up some revenue. It’s clearly working as an astute shopper would notice.
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