Do KR’s fundamentals justify its value proposition?

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. In the last year, that competition has only intensified with Amazon’s (AMZN) aggressive entry into the same market space via its 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 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 have been seen in its quarterly earnings results, the market has kept the stock a little over -24% below the stock’s high from September 2018 at around $33 per share. Even so, the stock is actually a little more than 20% higher from its trend low at around $20.40 per share. Does that recovery mark a turning point in the trend? The stock’s most recent quarterly report indicates that while the company is still investing heavily in its transformation plan, it could be starting to see traction from those strategies. If that’s true, the stock could offer a value proposition that is just too good to pass up.

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 $20 billion.

Earnings and Sales Growth: Over the last twelve months, earnings increased by about 7.32%, while sales were mostly flat, but positive at 1.07%. In the last quarter, earnings declined by almost -39 while revenues dropped by about -24%. The company operates with very narrow margins, as Net Income was about just 1.35% of Revenues for the last twelve months, and narrowed somewhat in the most recent quarter to 1.05%.

Free Cash Flow: KR’s free cash flow is healthy, at a little over $1.38 million. That marks an improvement from around $685 million in late 2018 and $1.1 a quarter ago, and translates to a free cash flow yield of 7%. The company has good liquidity, with $1.6 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 2.15. 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 2.53% 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 $10.83 per share. At KR’s current price, that translates to a Price/Book ratio of 2.28 at the stock’s current price. The stock’s historical average is 4.81. A rally to par with the historical average would put the stock above $52 per share. That provides a long-term target price not farm from the stock’s multiyear high point in early 2016. A more conservative target is offered by the stock’s historical Price/Cash flow ratio, which is 58% above the stock’s current price and offers a long-term target price at around $39.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The red diagonal line on the chart above marks the stock’s downward trend from November of last year to now. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. From that point the stock dropped to a low in July at around $20.40, but has rallied from that point to the stock’s current price at around $25. Immediate resistance sits right at the 38.2% Fibonacci retracement line at around $25 per share, with support at around $24. A break above $25 could give the stock momentum to push to at least $26.50, where the stock’s most recent next pivot highs from late September sit, and $27.50 within reach from that point. If the stock drop below $24, it could have room to fall to as low as around $22.

Near-term Keys: In the short-term, KR is at something of a crossroads, setting up a bit of a consolidation pattern over the last month or so. A decent bullish signal would come from a break above pivot resistance at around $25; that could offer a good opportunity for a quick momentum-based trade with call options or by buying the stock itself with an eye on the $26.50 to $27.50 level as a near-term target. A drop below $24, on the other hand could be an interesting signal to short the stock or to buy put options, using $22 as a decent point to take profits on a bearish trade. In the long term, I think the stock’s current price offers an interesting value-oriented opportunity. KR isn’t as big as most of the stocks it competes the most with, but as the lone company in that group whose focus is almost entire on the grocery business, they have also shown a willingness to adapt quickly and invest aggressively to innovate their business to adapt to changing consumer needs. I think that is something that is worth paying attention to.

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