The “herd mentality” can be a funny thing to think about in societal terms – but it’s a real thing in the stock market. The sheer number of publicly traded stocks on U.S. exchanges alone creates a wave of market data that no single person can handle alone, and that’s a big reason why it makes sense to use market media sources – business TV, radio and Web streams, for example – to keep track of what’s going on the market at any given time. The challenge is that, more often than not, most of those different channels end up talking about the same issues, and breaking news events. That tends to narrow the focus for the broader investing community to many of the same stocks – creating the “herd mentality” where everybody gravitates to many of the same stocks.
The herd mentality is a big reason why pandemic-driven concerns since March have driven most of the market’s attention to stocks in the Technology and Healthcare sector. That doesn’t mean it’s wrong – but it’s one of the biggest reasons that a lot of tech stocks are now trading a valuations that even the most bullish, growth-focused analysts are finding hard to justify. Herd mentality that drives stocks to extreme highs is a manifestation of investor’s tendency to want to invest in the “next big thing.” Along the way, other stocks tend to get less attention, simply because they’re not as fun to talk about.
One of the most un-sexy segments of the market to talk about is Food, Food Products, and Food Retailing. That’s because Food is just a regular part of daily life – and grocery shopping is just another chore that everybody has to get out of the way to keep pantries and fridges stocked. COVID-19 pandemic-driven conditions have created an unprecedented increase in home consumption, however, and that is something that has been a good thing for a lot of stocks in the Consumer Staples sector. While that is a trend that has also helped stocks in this sector rebound from their own bear-market lows in March, it has also kept them from enjoying the same kind of massive herd-drive increase that tech stocks have seen over the same period.
The divergence is actually an opportunity for value-focused investors, because while many tech stocks are trading at unreasonably high value multiples, there are a number of stocks in the Consumer Staples sector that have performed well in the last five months, but are still trading at very attractive multiples. That’s because while most sectors in the market are still dealing with declines in revenues, earnings, and cash flow, increasing home consumption has helped a lot of Food-related stocks improve their balance sheet strength and overall fundamental profile. Along the way, their “Fair Value” price targets have also been going up.
Kroger Company (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 strongly and now sits just a couple of dollars below its pre-pandemic high. 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 $26.8 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by about 69.44%, while sales increased almost 11.54%. In the last quarter, earnings improved more than 114% while revenues improved almost 44%. Like most Food retailers, KR operates with razor-thin margins, as Net Income was about 1.66% of Revenues for the last twelve months; however this number improved in the most recent quarter to 2.92%. That is a sign of strength, as the company’s big capital investments in e-commerce over the last few years are starting to yield useful results in an overall more efficient operating environment.
Free Cash Flow: KR’s free cash flow is healthy, and growing strongly, at $39 billion over the last twelve months. That marks an improvement from $1.8 billion in the quarter prior, $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 14.34%. Their strong, improving cash flow is a strong positive, and a reason that the company has good liquidity, with about $3.86 billion in cash and liquid assets. This number has also improved, from about $1.58 billion in the quarter prior.
Debt to Equity: KR has a debt/equity ratio of 2.02. 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. This number is a reflection of the capital-intensive investments in itself the company has made to stay competitive in its market. The results these efforts have begun to deliver is also seen by the fact that debt-to-equity dropped from 2.17 in the quarter prior.
Dividend: KR pays an annual dividend of $.72, which marks an increase from $.64 per share in the last quarter, and translates to a yield of about 2.06% at the stock’s current price. Even with the increase (which is very unusual under current market conditions), 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 $45.53 per share. That means that KR is undervalued by 32% from its current price a little below $35.
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 over the last year 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. The stock hovered in a range between around $34 and $32 until mid-July, when the stock broke above that range and has since begun to establish a new, higher range with support at $34 and resistance around $35.50. A break above $35.50 should see the stock test its pre-pandemic high around $37, while a drop below $34 could see it fall back to around $32.50, with additional room down to the 38.2% retracement line at around $31 if bearish momentum persists.
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 $34 as a good opportunity to initiate a bullish trade. If the stock drops below $34, you could consider shorting the stock or working with put options, with an eye on a very short-term profit target $31 and $32.50 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, with a Net Income profile that is also increasing. I think this is a solid stock to consider as a long-term investment right now.