- Kroger has seen a great 2020 for obvious reasons.
- The company sees some headwinds in 2021, but adjusting for the abnormal 2020 the outlook is still very solid.
- I still like Kroger here as the company continues to reward all stakeholders, providing an excellent base for long-term results.
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Kroger (NYSE:KR) has been a sleeping giant which to some extent has awoken in recent years. Almost exactly a year ago, I looked at the prospects for the business amidst the outbreak of the pandemic, which resulted in spectacular growth numbers at the start of the Covid-19 crisis, as it was unknown of course how severe and how long the health crisis would last at that point in time.
A year later the situation looks better, but it is safe to say that the pandemic continues to impact the entire world, warranting an update on the thesis. The continued longevity of the crisis has resulted in a boom year which allowed Kroger to keep most stakeholders happy, and even as 2021 earnings are set to take a beating vs. the 2020 results, investors should not read that much into this trend. After all, the actual earnings numbers seen this year are still very solid, meaning that Kroger still represents real value here.
Back To April 2020
When I looked at the investment case in April I noted that Kroger was a reliable and defensive name, having just reported a 2% increase in identical sales for 2019, resulting in $122 billion in annual sales on which the company reported an EBIT number of $2.3 billion, for slim margins of 1.8%.
Net earnings of $1.66 billion worked down to $2.05 per share, with adjusted earnings coming in at $2.19 per share as the adjusted numbers cannot automatically be assumed by investors as the company takes charges including severance, pension-related charges, and store closures.
With earnings power around $2 and shares trading around the $30 mark, the situation looked reasonable, although past deal-making resulted in some debt, with net debt ending in 2019 at $13.9 billion, for a 2.5 times leverage ratio with $5.6 billion in EBITDA. A more active stance to shareholder payouts (dividends and share repurchases) and M&A awoke the sleeping stock from a range of $7-$15 during much of the 2000s to a high of $40 in 2015. Ever since, shares have largely traded in a $20-$30 range in more recent years.
With the company originally guiding for >2.2% identical sales growth and earnings at $2.30-$2.40 per share the outlook looked pretty reasonable for 2020. I furthermore was really impressed with the Ocado partnership, providing a real efficiency and online boom to the business.
When Covid-19 arrived shares traded at $28 as volatile trading action took place in a range between $28 and $34, as investors were actively factoring in the impact of the pandemic on the business. Of course a hoarding effect and restaurant closures would benefit the company, yet protection measures, employee bonuses and the impact of the economy might be felt as well. The price action clearly indicated that investors were betting that the net effect would be positive.
For March the benefits were easily seen with identical sales up 30%, which of course was an unprecedented sales growth number, as at the time the impact on the bottom line was not yet known. While the set-up looked interesting with shares trading at 13-14 times earnings and this being a defensive name, the market as a whole had seen a huge move lower by April of last year. This movement was pretty much the only reason why I did not initiate a position, as bargains were appearing left and right. When the company reported solid first quarter results, including a big boom in earnings and a big reduction in net debt in June, I concluded that I was buying a stake at $32 this past summer.
Since buying a stake in June I have collected some dividends and with shares trading at $36 and change they have seen a reasonable near 15% all-in return, yet that still marks underperformance vs. the wider market, leaving me questioned what to do with the stock here.
In September the company reported strong second quarter results, although the biggest increase in sales was a thing of the past already, which is no surprise after the initial hoarding. Second quarter identical sales rose nearly 15% as the company indicated that it saw full year adjusted sales between $3.20 and $3.30 per share, while net debt was down to $11.0 billion already.
Third quarter identical sales were up 11%, resulting in an updated earnings guidance between $3.30 and $3.35 per share. Net debt rose to $11.7 billion, in part because the company is actively using cash flows to buy back stock as this is no major concern, even if EBITDA would normalize to normal levels.
In March the fourth quarter results, and thus full year results for 2020 indicated that identical growth remained firm at 10% and change for the final quarter of the year, certainly as the pandemic was gaining strength again that quarter. Amidst all of this, the company reported a $10 billion increase in annual sales to $132 billion, with adjusted earnings per share improving to $3.47 per share.
The fact that this is an unusual year is seen in the guidance as the company sees 2021 identical sales down between 3 and 5%, with adjusted earnings seen at a midpoint of $2.85 per share. This is no surprise and looks sound as the company initially guided for 2020 sales at a midpoint of $2.35 per share a little over a year ago. Nonetheless, It is clear that certainly in the first half of the year there is positive impact from the pandemic on the results, which for this reason might even create difficult 2022 comparables. Net debt came in at $12.0 billion by the end of the year as the boom in earnings has been relatively limited to some other grocery chains, perhaps because the company takes more measures and invests more into the stores and online operations.
Based on the forward guidance, shares trade at 12-13 times earnings which is a lower multiple as was the case last year, as net debt has been cut by $2.0 billion and investments have continued.
In this lower interest rate world, the earnings yield looks quite compelling if you ask me, even if interest rates have inched higher a bit recently. I think that shares continue to look rather cheap and the company is investing for all of its stakeholders in the long run, yet I do not see an immediate trigger for outsized gains. That said, a balanced cash flow allocation to shareholders looks good in the long run. I am sticking to my existing allocation here after the relative valuation gap with the entire market only been on the increase and Kroger is still doing really well.
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Analyst’s 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.
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