The Kroger Co. (NYSE:KR) operates as a food and drug retailer in the United States. We first wrote about the company back in June 2022, initiating a “buy” rating, as we have claimed that KR may not be too affected by low consumer confidence levels. Later, in October 2022, we reiterated our bullish thesis due to the firm’s strong financial performance. Our last article about KR has been published in April 2023, which again reiterated our bullish view on the firm.
The aim of our article today is to take a look at the firm’s latest quarterly results, and assess, whether the previously established “buy” rating is still valid based on the fundamentals of the business. We will conclude our article by looking at a set of traditional price multiples to gauge whether the current share price could present an attractive investment opportunity or not.
Quarterly results
Kroger has reported quarterly earnings results on the 20th of June 2024, beating analyst estimates both top- and bottom-line, while reaffirming the outlook for the full year.
Identical sales have increased by 0.6% year-over-year (without considering fuel), operating profit have come in at $1,499 million, compared to the 1,669 million in the prior year, and Adjusted EPS declined to $1.29 from past year’s $1.32.
Let us look a bit more into the details to identify the factors that have been driving these changes. Let us start from the top of the income statement – from sales.
Sales
Sales have reached $45,269 million in the fiscal first quarter of 2024, representing a roughly 0.6% increase compared to the same period in the prior year. The increase in sales can be mainly attributed to two strategic initiatives: Leading with fresh, and Accelerating with digital.
As part of the Leading with fresh initiative, the firm has introduced more than 340 “Our Brands” products, it has set a new record for quarterly floral sales and has launched an entirely new brand called Field & Vine, which offers regionally grown berries.
As a result of the Accelerating with Digital, the firm has managed to achieve a 17% increase in delivery sales, a 9% increase in digitally engaged households and set a new record for quarterly pickup fill rate.
We find these results quite attractive. While Kroger is not a fast growing business, which is nothing uncommon in the food retail space, it has managed to beat analyst estimates top- and bottomline. It has launched a wide range of new products, has started a new brand and has significantly increased its digital presence. We believe these are all indications that KR tries to constantly innovate and improve its engagement with the customers in order to gain market share. In our view, these are all key elements to long term success in the food retail space.
Margins
While the company’s sales have marginally increased in the prior quarter YoY, their profitability has slightly deteriorated. Both gross-, operating- and net profit margins have contracted.
The gross margin has declined 7 bps year-over-year, falling to 22.4%, due to the lower pharmacy margins and increased price investments. The new “Our Brands” product line, has however partially offset these negative impacts. The Operating, General & Administrative expenses have increased due to the investment in associate wages and increased incentive plan costs. The execution of cost saving initiatives have only partially offset these negative impacts.
As a result of the deterioration in profitability, EPS has declined by as much as $0.03 compared to the same period in the prior year.
While the decline may sound alarming at first, when we compare KR’s profitability figures with those of its peers/competitors, we can see that KR is not underperforming any of them substantially. But also not outperforming any of them significantly.
Guidance
The firm has reaffirmed its guidance for the full year, which is also a good sing in our view. Although relatively slowly, they still expect to grow compared to the prior year and still expect to generate more than enough profit and free cash flow to cover their returns to shareholders.
Considering that consumer confidence has been relatively weak in the prior months with significant volatility, we still believe that KR could provide the much-needed safety in this turbulent economic environment to investors. While the growth may not be stellar, it appears to be realistic and achievable, and it can result in attractive returns for shareholders.
Capital allocation
There are currently four main topics within the firm’s capital allocation strategy: quarterly dividend payments, share repurchases, growth and de-leveraging.
The firm intends to keep paying its safe and sustainable quarterly dividends, which they are also aiming to increase gradually in the future. With a relatively low payout ratio, strong free cash flow and consecutive increases of dividend payments in the decade, we believe that these ambitions that the firm has indicated are quite credible and achievable.
KR has recently paused its share repurchase program, which we believe is reasonable, as the firm is intending to focus more of its capital on the de-leveraging. Currently, the company’s net total debt to EBITDA ratio is 1.25 compared to the 1.34 in the prior year, and significantly below the target of 2.3 to 2.5.
All in all, we believe that the firm is well-positioned to both grow and return value to its shareholders in the long term. KR’s balance sheet, strong free cash flow generation and relatively low payout ratio indicate that the dividends are safe and sustainable and are not likely to be cut or paused in the coming quarters.
Valuation
Just like in our previous articles, we will assess KR’s valuation using a set of traditional price multiples. The following table compares KR’s figures with its own historic averages as well as with the consumer staples sector median.
We can see that according to most metrics, KR is currently selling at a slight discount to both its own historic values and the sector median. If we narrow down the peer group to firms in the food retail industry, the comparison becomes somewhat more meaningful, as these businesses are much more comparable. The following table presents this comparison.
Based on these metrics, KR’s stock is trading about in line with that of its peers. At this point, we believe that KR is fairly valued based on these numbers. Further, based on the firm’s profitability metrics, growth and balance sheet, we do not believe that a significantly higher or lower valuation could be justified. Due to the uncertain macroeconomic circumstances, and the potential deal with Albertsons (ACI), we believe, however, that KR could be an attractive investment at this point.
Conclusion
KR has beaten analyst estimates both top- and bottomline in the prior quarter. The firm has achieved a sales increase of 0.5% year-over-year, but margins have contracted and adjusted EPS has declined as much as 5%.
The company has maintained its full year 2024 guidance, indicating low single digit sales growth for the rest of the year and strong cash flow generation.
KR aims to keep paying and increasing its quarterly dividends in the future. The share buybacks have been temporarily stopped due to growth and de-leveraging initiatives.
In our view, the firm remains attractive from a fundamental and valuation point of view in the current volatile macroeconomic environment. For the reasons above, we maintain our bullish rating.