One of the primary elements I like to use to filter through the tens of thousands of stocks in the market is dividend payout.
In the broadest sense, companies that pay a consistent dividend only do so because they have the financial resources – including healthy liquidity, free cash flow, and operating margins – to sustain the dividend over time. What about the majority of publicly listed stocks that don’t pay a dividend? Lack of a dividend doesn’t mean that a company doesn’t have the same fundamental, financial characteristics – but even though that can still be true, I gravitate to dividend-paying stocks over fundamentally strong, non-dividend payers because dividend payments also imply a management characteristic that I think is important.
If dividends are generally only paid when a company has the financial resources to sustain it, it also follows that the management teams that commit to paying dividends understand the usefulness, and importance of returning value to shareholders. I also like dividends as a superior form of returning value versus stock buybacks, which are also common, because it puts cash in a shareholder’s account, where stock buybacks take place over time and may or may not translate to a proportional increase in the stock’s price.
For most of the last four years, 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 all of the past year’s focus on inflation, interest rates, and war in Ukraine as the basis for a defensive approach to a lot of the analysis I’ve done. I think that when economic conditions become more difficult, positioning defensively 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 conservative, useful investments since 2018. I also think that stocks in the Food Products industry will continue to be a useful place to keep your money working for you. The other thing I like about this industry is that dividend-paying companies are pretty easy to find.
The caveat to looking for investments in Food Products stocks, as with any industry, is that not all stocks are created equal. Not only do not all companies share the same kind of fundamental strength, it’s also true that not all Food Products stocks might offer a good value. That’s an important distinction to make, because just as a stock in a new, long-term upward trend typically outpaces the underlying company’s fundamental strength, stocks in downward trends aren’t categorically driven by fundamental weakness.
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. This is a stock that followed a strong upward trend through 2021 to a peak in April of 2022 at almost $63 per share. From that peak, the stock dropped into a clear downward trend that bottomed in October of last year at around $42. The stock has struggled to establish a clear trend from that point, rallying to a peak at around $50 in April and May, and then falling back to a low at around $44 to start June. The stock has been picking up some bullish momentum, and as of this writing has managed to climb to around $47 per share.
KR has been among the most proactive innovators in the entire Consumer Staples industry over the past few 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. They also represent significant capital investments that management has signaled will continue for at least the next couple of years. Add to the mix that management announced an increase in its dividend payout after the latest earnings report, and I think the stock’s fundamentals could give a bullish investor good reason to add KR to a diversified portfolio; but that begs the question, is it also a good value? Let’s dive in and take a look.
Fundamental and Value Profile
The Kroger Co. (KR) is a food retailing company that owns and operates supermarkets, multi-department stores and fulfillment centers throughout the United States. The Company manufactures and processes some of the food for sale in its supermarkets. The Company operates approximately 2,800 owned or leased supermarkets, distribution warehouses and food production plants through divisions, subsidiaries, or affiliates. These facilities are located throughout the United States. The Company also owns store equipment, fixtures, and leasehold improvements, as well as processing and food production equipment. The Company offers personalized, order online, pick up at the store services and also provides home delivery services. In addition, the Company also retails products online. The Company’s brands include Private Selection, The Kroger, Big K, Check This Out, Heritage Farm, Simple Truth and Simple Truth Organic. KR has a market cap of $33.9 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by 4.14%, while sales improved by 1.27%. In the last quarter, earnings improved by 52.53% while revenues also rose, by 29.7%. Like most Food retailers, KR operates with razor-thin margins, as Net Income was about 1.71% of Revenues for the last twelve months, and strengthened in the most recent quarter to 2.13%.
Free Cash Flow: KR’s free cash flow is healthy, at $3 billion over the last twelve months. That marks an increase from $2.8 billion a year ago, and $1.5 billion in the quarter prior. The current number translates to a useful free cash flow yield of 9.02%.
Debt to Equity: KR has a debt/equity ratio of 1.11. 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 adequate to repay their debt, and is a sign of strength, with about $3.8 billion in cash and liquid assets (versus $2.1 billion in the quarter prior), against $121 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 $1.16, which marks an increase from $.64 per share in early 2020, $.72 per share at the beginning of 2021, $.84 to start 2022, and $1.04 in the last quarter. The current payout translates to a yield of about 2.47% at the stock’s current price. The increasing dividend over the last three years should be taken as a sign of 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 $49 per share. That means that KR is modestly undervalued, with 3.75% upside from its current price, and a useful bargain price at around $39.50 per share.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The chart above displays the last year of price movement for KR. The red diagonal line marks the stock’s downward trend from a peak at around $63 in September of last year to its October low at around $42; it also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. The stock managed to test an intermediate-term peak at around $50 in December of last year, and again in April and May of this year; after the most recent peak at that level, however, the stock dropped sharply, finding its latest pivot low at around $45 before starting to rally over the last couple of weeks to its current price a little above $47 per share. Immediate resistance is at $48, right around the 61.8% retracement line, with current support at $47. A push above $48 could have room to rally to about $50 before finding next resistance at the latest major high seen in May, while a drop below $47 could have downside to about $45 before finding next support.
Near-term Keys: KR’s fundamentals are improving, which along with its increasing dividend is a positive sign; however the stock’s current price doesn’t represent a useful value at this point in time. I’d keep the stock in a watchlist and pay attention to the stock’s price action and next earnings report to see if that changes before thinking about using the stock for a value-oriented investment. That means that the best opportunities to work with the stock lie in short-term trading opportunities. You could use a break above $48 to consider buying the stock or working with call options, with an attractive near-term target at around $50. A drop back below $47 could be a signal to consider shorting the stock or buying put options, using $45 as a reasonable profit target on a bearish trade, and $42 possible if bearish momentum accelerates.