Over the last year or so grocery stocks have been one of a number of industries that have held my interest as an analyst. Part of that is because of the extremely extended state of the market’s bullish trend, which has stretched well past the decade mark. The longer any given trend lasts, the more my training in technical analysis tells me it should be due for a major reversal. At the top of long bullish trends, that means that stocks in more defensive industries start to become more and more compelling.
Another part of the reason for my interest in grocery stocks is the relatively small group of publicly traded stocks that exists. In terms of pure grocers, there is really only one true national name, and that’s the Kroger Co. (KR). That doesn’t mean that KO doesn’t face intense competition, or that it only comes from smaller, regional challengers. In fact, much of the company’s struggle is to deal with pressure from big-box retailers like Walmart (WMT) and Target Stores (TGT) with a bigger footprint and aggressive strategies that keep margins in the industry running at razor-thin levels. Over the last year or so, that competition has only intensified with Amazon’s (AMZN) aggressive acquisition of Whole Foods. That has forced every company in the industry to find creative ways to evolve and adapt its business models in quick fashion. For KR, that has meant investing heavily in remodeling its stores, diversifying its revenue stream and implementing innovative technologies to make their grocery shopping experience equally responsive to moves made by its bigger brethren.
Over the last couple of months, as the company’s capital-heavy investments, including a big emphasis on alternative revenues streams like Kroger Personal Finance and Kroger Precision Marketing, have started to show positive results on the company’s earnings reports, the market has started to push the stock off of a long-term downward trend low below $21 per share, giving it a strong push into the end of 2019 to a peak above $29 per share. The stock is a bit below that point now, but that really just looks like a good pulllback within an intermediate upward trend. Technically, that is a set up that a lot of short-term traders like to see, and I think the stock’s fundamentals certainly could give a bullish investor good reason to think about taking a long-term position; but are they strong enough to say the stock is still a big value? I think so, with a single cautionary caveat. Let’s dive in and take a look.
Fundamental and Value Profile
The Kroger Co. (KR) manufactures and processes food for sale in its supermarkets. The Company operates supermarkets, multi-department stores, jewelry stores and convenience stores throughout the United States. As of February 3, 2018, it had operated approximately 3,900 owned or leased supermarkets, convenience stores, fine jewelry stores, distribution warehouses and food production plants through divisions, subsidiaries or affiliates. These facilities are located throughout the United States. As of February 3, 2018, Kroger operated, either directly or through its subsidiaries, 2,782 supermarkets under a range of local banner names, of which 2,268 had pharmacies and 1,489 had fuel centers. As of February 3, 2018, the Company offered ClickList and Harris Teeter ExpressLane, personalized, order online, pick up at the store services at 1,056 of its supermarkets. P$$T, Check This Out and Heritage Farm are the three brands. Its other brands include Simple Truth and Simple Truth Organic. KR has a market cap of $22.6 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by about -2.08%, while sales were mostly flat, but positive at 1.09%. In the last quarter, earnings improved by almost 6.82% while revenues saw a slight drop at -0.69%. The company operates with razor-thin margins, as Net Income was about just 1.3% of Revenues for the last twelve months, but narrowed in the most recent quarter to just 0.9%. That is a concern, and marks the caveat I mentioned earlier. KR doesn’t have a lot of room for error, so a continued decline in this measurement could negatively impact the company’s liquidity.
Free Cash Flow: KR’s free cash flow is healthy, at a little over $1.67 billion. That marks an improvement from $1.38 billion at the beginning of the fourth quarter of 2019, and $685 million in late 2018, and translates to a free cash flow yield of 7.42%. Their strong, improving cash flow is a strong positive, and a reason that the company has good liquidity, with $1.57 billion in cash and liquid assets. This number has also improved, from about $1.3 billion at the end of 2018.
Debt to Equity: KR has a debt/equity ratio of 2.14. This is higher than I usually prefer to see, but isn’t unusual for Food Retailing stocks. The company’s balance sheet indicates that operating profits are more than adequate to repay their debt. The fact this number jumped from 1.54 two quarters ago shouldn’t be ignored, and is another reflection of the capital-intensive investments in itself the company is making to stay competitive in its market.
Dividend: KR pays an annual dividend of $.64 per share, which translates to a yield of about 2.28% at the stock’s current price.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for KR is $10.89 per share. At KR’s current price, that translates to a Price/Book ratio of 2.57 at the stock’s current price. The stock’s historical average is 3.05. A rally to par with the historical average would put the stock a little above $32 per share. That provides a long-term target price about 18.5% away from its current level, which is nice but not incredibly compelling; however the stock is also trading 26.5% below its historical Price/Cash Flow ratio, lifting that long-term target price to about $35.50 per share.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above marks the last year of price movement for KR. The stock’s upward trend since late July is clear, and the pullback from late December to now against that backdrop looks like a typical bullish pullback within that longer trend. Immediate resistance is a little above $29 per share; use $29.50 as a strong indication the stock is breaking resistance and could rally to a new 52-week high between $31.50 and $33 per share, based on previous peaks in late 2018. Immediate support appears to be pretty close to the stock’s current price, at about $27.75. A drop below that point could see the stock fall to about $25.50 before its next support test.
Near-term Keys: For a short-term trade, the probability right now looks best on the bullish side; if you want to be aggressive with a short-term trade by buying the stock or working with call options, you could use a bounce off of support around $27.75 as an opportunity to initiate a trade; otherwise, wait for a break above $29.50 as a stronger bullish signal. If the stock drops below support, you could consider shorting the stock or working with put options, with an eye on a very short-term profit target at around $25.50 per share. I like KR’s value proposition; however, the company’s narrowing Net Income does loom as a warning sign. If you want to be very conservative, wait for the company to show an improvement in this area before taking a long-term position seriously.