Since 2019, I’ve used economic uncertainty – first from a year-long trade war through 2019, and then of course the COVID-19 pandemic starting in 2020, and certainly broadly inflationary news to this point in 2022, from rising consumer prices and producer input costs, continuing conflict between Ukraine and Russia, and what most now expect to be a long-term, possibly even permanent shift in economic and geopolitical relationships between Russia and the rest of the Western world, and rising interest rates – as the basis for a lot of the analysis, and certainly some of my own investments in the marketplace. I think that when economic conditions become more difficult, defensive positioning by focusing on industries that are traditionally less sensitive to the cyclicality of economic health makes sense. It’s a strategy that has helped me make a number of useful investments throughout the past three and a half years.
Economic and market uncertainty has manifested itself this year with a drop by all of the major market indices to their own bear market levels last month.
The market has been trying to stabilize from those levels, but there continues to be a lot of signs out there that conditions will remain difficult. For me, that means that paying attention to sectors and industries that are less exposed and less sensitive to economic cyclicality should continue to be a smart strategy for conservative, value-minded investors.
In the Consumer Staples sector, the Food Products industry is one that I like to pay particular attention to. 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. Inflation that ripples to the consumer level means that household budgets get tighter – but the need for the same basic products doesn’t change. That puts a premium, in my mind on value-based food products that help families stretch every dollar they spend as much as possible.
Kroger Company (KR) is the largest traditional food retailer in the United States, and a company that I’ve kept an eye on for some time. After following a strongly bullish trend for most of the past year, the stock peaked at around $63 at the beginning of April; but the inflationary pressures I just described pushed the stock sharply lower, finding short-term trend support at around $47 in the middle of May. From that point, the stock has started rallying again, peaking most recently at around $53 at the end of last week.
KR 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, building localized, automated warehouse facilities throughout the U.S. and online shopping and curbside delivery that is now in place in 95% of its coverage area. Many of these initiatives have yielded positive results on the company’s earnings reports, and have enhanced the company’s ability to compete against larger rivals like Wal-Mart and Target Stores. I think the stock’s fundamentals could give a bullish investor good reason to include KR in a diversified portfolio, with the current bullish bounce lending weight to a growth-oriented investor’s strategy; but that begs the question, where is the stock’s useful discount price compared to its current price activity? 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 $37.1 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by 12.35%, while sales improved by 7.52%. In the last quarter, earnings rose 16.67% while revenues increased by 3.73%. Like most Food retailers, KR operates with razor-thin margins, as Net Income was about 1.2% of Revenues for the last twelve months, but did see this metric strengthen in the most recent quarter to 1.71%.
Free Cash Flow: KR’s free cash flow is healthy and growing, at $3.7 billion over the last twelve months. That marks a big improvement from $3.1 billion in the last quarter, and $1.9 billion a year ago. The current number translates to a free cash flow yield of 19.15%.
Debt to Equity: KR has a debt/equity ratio of 1.36. This is higher than I usually prefer to see, but also isn’t unusual for Food Retailing stocks. The company’s balance sheet indicates that operating profits are more than adequate to repay their debt, with $2.9 billion in cash and liquid assets against $12.8 billion in long-term debt. Their long-term debt is a reflection of the capital-intensive investments in itself the company has made to streamline its operations, modernize and automate its own supply chain, and to stay competitive in its market.
Dividend: KR pays an annual dividend of $.84, which marks an increase from $.64 per share in early 2020 and $.72 per share at the beginning of 2021. The current payout translates to a yield of about 1.61% at the stock’s current price. The increasing dividend over the last two years should be taken as management’s confidence in their operating model and ability to keep the business growing in the long term.
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 $50.50 per share. That means that KR is somewhat overvalued, with about -2% downside from its current price, and a practical bargain price at around $40.50.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above displays the last year of price movement for KR. The stock’s upward trend began in June of last year at a low of about $37, and peaked at the beginning of April at $63. From that peak, the stock dropped to about $47 in mid-May, but has picked up bullish momentum since then, hitting immediate resistance at around $53 at the end of last week, with current support expected at around $50 where the 50% retracement also sits. A push above $53 should see near-term upside to about $55 before hitting next resistance, with additional upside to about $59 if buying activity increases. A drop below $50 should find next support at around $47, where the 61.8% retracement waits.
Near-term Keys: KR’s fundamentals are solid, with strengthening Free Cash Flow providing a strong basis for the company’s financial and operating health; but even with the stock’s drop since April it still hasn’t approached a useful value-based price. That means that the best probabilities lie in short-term trading strategies. A push above $53 could be a good signal to consider buying the stock or working with call options, with $55 providing a practical, quick-hit, bullish profit target, while a drop below $50 should be taken as a signal to think about shorting the stock or buying put options. In that case, use $47 as a useful profit target on a bearish trade.