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Short Idea - Kroger Co

|Includes: AMZN, Kroger Co. (KR), SWY, SYY

Kroger (NYSE:KR) is perhaps the best performing US food/grocery stock in the last two years. Growing comparable store sales and margins. KR is an all around excellent operation in a cut-throat business. So if KR is strong why do I even mention shorting it? - The reason is its massive stock price outperformance, which was driven by the fundamentals and then momentum took over. Indeed, KR had a massive 69% price increase in 2014, making it one of the top S&P500 stocks in 2014. And that came on top of 45% rise in 2013. This is rather eye popping performance since we are not talking Tesla here. KR is a mature business in an industry with entrenched competition.

Valuation Is Stretched

KR is currently going for TTM Price/Earnings of ~22. Compare that with long term average PE of 11-13. Talk about multiple expansion. KR would be the textbook example of that. Other metrics such as PEG and Price/Sales are equally elevated. Except KR dividend yield, which in the last 5 years floated in 1.75 - 2% band, now is registering at meager 1%.

Analysts and the "Smart Money"

Personally, I do not pay any attention to analysts when evaluating fundamental merits of an investment. I will not go into reasons why as it would be a long digression. However, there is no denying the fact that analysts drive institutional sentiment. And sentiment is what will make this trade work. According toYF there are 5 EPS Up revisions in the last 30 days. I do not have a shadow of a doubt that KR will beat the expectations for the Q4. The key is 2015 guidance, that will struggle against difficult comparables of a stellar 2014 year.

Now to the "smart"money that seems to have began moving out of the name ahead of March 5th earnings report. Take a look at the daily chart. As you can see there is a clear break in the price action.

This underperformance is meaningful as it tells us that sentiment turned dramatically. Given that the broad market was steadily rising during the same period. Even more astonishing was today Oppenheimer re-iterated BUY and bumped its target price to $80. Yet the stock closed down! Contrast that against Dow adding 0.85% gain for the day. If this does not tell you that "smart" money is leaving, then I do not know what will. Here is the recent history of Analyst action on Kroger.

The Trade

As old adage says - 'what goes up must come down'. The old Kroger must give back some of its well deserved gains. I believe that now is the time because the expectations are at the highest level ever. The story of consumers spending bump from Oil price drop has played out (with no observable bump). There is simply a physical limit to how much a business can squeeze out of its asset base. Add to the headwinds a minimum price increases that are sweeping across America like a grass fire. These should instill caution into any management team.

As I see there are two ways to go about trading KR. First is to trade earnings directly. I favor a bear put spread. Perhaps a Mar 70 / 65 put spread for a less than $1 debit. This is a mathematical trade with favorable odds. Let's say that the stock will jump up or down after the earnings randomly. Let's assume that the story we put together here sways the odds of a down move from random 50% to 66%. The spread pays us 4 : 1. We can earn a maximum of $4 while risking $1 a share. This is a very favorable bet.

Another way is wait until after the earnings. Then go short Kroger. As Kroger options will get cheap once the earnings are in the books, I would add some cheap long calls to hedge my short position against a move up. While the first trade will last a few days. This short position can stay on anywhere from weeks to months.

Originally published at http://optionsforum.net/topic/166/short-idea-kroger-co

[I got tired struggling to upload pictures to SA]

Disclosure: The author has no positions in any stocks mentioned, but may initiate a short position in KR over the next 72 hours.