As more and more states in the United States, and indeed other countries across the globe begin to acknowledged the reality that COVID-19 is here to stay, they are also making moves to reopen local, state and national economies to get business activity underway again. That means trying to strike a balance between the broader health risk the pandemic continues to pose, and measures that must be taken to limit its continued spread and the need to get people back to their normal lives – back to work, back to school, for example – in some form.
The initial outbreak that spurred shelter-in-place and quarantine orders across the globe shut down the global economy in a way that is being more completely understood as economic data pours in – corporate earnings, unemployment, and so on. The fact that while research is ongoing, and there are even some encouraging signs of progress on the biopharmaceutical front, the truth is there is still neither a vaccine against the virus, nor any practical combination of anti-virals to manage it. That means that as economic activity increases, the onus is on individuals to take their own precautions to protect themselves – which isn’t necessarily a given. It also keeps pressures on the healthcare sector and on medical professionals to do the best they can with the resources they currently have at their disposal.
A reopening economy is probably a good thing – provided, as Fed chair Jerome Powell noted in an interview Sunday on 60 Minutes, a big spike in new infections isn’t seen that might force governments to re-impose previous restrictions. One of the economic realities of those initial restrictions was a massive surge in home stockpiling of basic supplies, including food storage for near-term and extended time use. That’s why a lot of Consumer Staples stocks, including Food stocks in particular have actually performed quite well over the past couple of months.
I’ve noticed that a number of reports about the Food industry have pointed not only to the healthy sales that stocks like Kroger Company (KR) have seen during the pandemic, but also how the companies that have been investing in omnichannel marketing and distribution methods have begun to separate themselves from the pack. That makes sense, as a lot of people are starting to adopt more online shopping, with curbside pick-up or even home delivery as a way to follow social distancing guidelines. The quasi-forced adoption of those new methods, which U.S. consumers have shown to be slow to embrace before the pandemic, seems likely to continue to show healthy growth for those forward-thinking companies that starting putting those methods in place before hand. I think that could be even more true when you consider that the reality that social distancing guidelines aren’t going to go away even as business reopens. Walk into a grocery store and you should notice very quickly that while you can probably get most of what you need, business is definitely NOT as usual. At my own Kroger store, for example, there are signs in each aisle designating direction of traffic flow, with one-way traffic in each aisle clearly established. Go against the specified aisle flow, and you’ll draw glares from other customers and maybe even a growl or two to add peer pressure to your shopping experience.
Another element that is going to play a role in this industry are indications that the pandemic is also limiting supply of certain food items, including beef, chicken and other proteins. That is forcing grocers to impose purchasing limits on those items, and which will also likely result in higher prices and so curb demand in those areas. How much of an ongoing effect that will continue to have remains to be seen, but it is a risk that investors should factor in to their analysis for the industry.
KR is a stock that clearly reflects the pattern I described earlier. After falling from a high at around $36 to a march low at around $28, the stock has rallied nicely, rising about 12.6% as of this writing. The last couple of days have seen the stock drop back a bit from a more recent high at around $34, but along with the stock’s steady rebound through April, that seems to simply be setting up a new, interesting pullback pattern within this new, short-term upward trend. The company has been among the most proactive in the entire Consumer Staples industry over the past couple of years, investing heavily in alternative revenues streams like Kroger Personal Finance and Kroger Precision Marketing, as well as online shopping and curbside delivery that is now in place in 95% of its coverage area. These have started to show positive results on the company’s earnings reports, and seem to bode well for the company’s ability to compete against larger rivals like Wal-Mart and Target Stores. 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? 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 $24.9 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by about 18.75%, while sales increased almost 3%. In the last quarter, earnings improved by a little more than 21% while revenues improved a little over 3%. The company operates with razor-thin margins, as Net Income was about just 1.36% of Revenues for the last twelve months, and narrowed in the most recent quarter to 1.1%. That is a concern, and does bear watching in the quarters ahead. 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 $1.8 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 7.15%. Their strong, improving cash flow is a strong positive, and a reason that the company has good liquidity, with about $1.58 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 2.17. 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 has made to stay competitive in its market.
Dividend: KR pays an annual dividend of $.64 per share, which translates to a yield of about 1.97% at the stock’s current price. KR’s dividend payout is less than 1/3 of its earnings, which is very conservative.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $40.66 per share. That means that KR is undervalued by 28% from its current price a little below $32.
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, marked by the red diagonal line that also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. April saw the stock drive above the 38.2% Fibonacci retracement line as it extended an intermediate upward trend into a long-term time frame. In the last week, the stock has fallen back off of highs around $34 and is about $1 above support from the 38.2% retracement line at around $30.50. A pivot and reversal off of that support line should offer upside to at least the $34 mark,, with the stock’s 52-week high around $36 attainable if bullish momentum holds. If the stock falls below $30.50, its next expected support point should be at around $29 back on previous pivots as well as the 50% retracement line, with additional support around $27 in bearish momentum increases.
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 $30.50 as a good opportunity to initiate a bullish trade. If the stock drops below $30.50, you could consider shorting the stock or working with put options, with an eye on a very short-term profit target at around $29 per share. I like KR’s value proposition and overall fundamental profile; it is among very few companies that are showing positive signs of growth in the current pandemic world, even with their narrow Net Income profile. I think this is a solid stock to consider as a long-term investment right now.