Food Fight: 3 Grocery Stocks You Need to See

Ben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Supermarkets are an essential part of the way we live. Unless you farm, you probably frequent your nearby grocery store.  An investment in this industry could mean good returns in the long run.

Based on a report by the Food Marketing Institute, the average American purchases groceries 2.2 times a week. These shoppers buy over $600 billion worth of food every year.  While growth might not be as rapid as other industries, it is constant and reliable. Let's take a closer look at three companies potentially poised to cash in on full carts and hungry shoppers.

Go long 

Kroger (NYSE: KR) runs 2,419 supermarkets and multidepartment stores under 24 banner names that employ 343,000 people in 31 states. Kroger has had good, recent performance with same supermarket sales increasing 3.3% and overall sales up 3.4%. Net earnings were $481 million, which represents a 9.60% increase year over year. This increase stems from strong operations, a lower share count that came from share buybacks, and a low LIFO expense.

(When a company uses FIFO (first in, first out) during its day-to-day operations but wants to report using LIFO on its financial statements it creates a LIFO reserve.  LIFO (last in, first out) expense is the amount that income has been reduced by during the current period from using LIFO.)

One worrisome aspect of Kroger is its gross margin of 20.65%. This is competitively low and has been consistently declining for the past 10 years.  This means that a company has been retaining less and less of each dollar earned.  As its margins shrink, Kroger earns less.  

Kroger overcomes this low margin by focusing on improving market share by investing in new stores, remodeling old stores, and providing employees with leader training programs. This strategy helped Kroger double its market share in Ft. Worth over the past five years and increased overall market share by 0.2% in 2012.  Increased market share can lead Kroger to higher revenue.  Even though the company is retaining less of this revenue, it's making enough in extra sales to offset  the decreased margin, leading to an overall increase in earnings. 

Kroger has a beta of 0.66, which signifies low volatility if the market should drop. It is a consistent, safe stock for you risk-averse investors. When the economy is good, people buy premium brands. When it's bad, they can buy Kroger’s Simple Truth and other corporate brands.

Simple Truth currently has 450 products, and the company expects to add 75 more by the end of 2013. Total corporate brands represent 23.7% of Kroger's total sales, an increase of 30 basis points year over year.

Kroger offers a quarterly dividend of $0.15 per share, for a 1.80% yield. The company has also made share repurchases in order to increase investor wealth. The stock won’t grow very fast, but it is a good, low risk investment.

A safe investment

Safeway (NYSE: SWY) owns roughly 1641 retail location. Last quarter, Safeway had 63.10% earnings growth that stemmed from higher-than-expected tax benefits. These benefits dropped the company’s tax expense from 30% to 2.1% and was responsible for $0.14 of its $0.49 earnings per share. Without the tax break, earnings per share still increased 17% thanks to same-store sales and market-share increases of 1.5% and 25 basis points respectively.

The company recently sold its Canadian branch for a whopping $5.7 billion, which is slightly more than its entire current market cap of $5.65 billion. The company plans on using $2 billion of the proceeds to pay off debt and lower its high debt-to-equity ratio of 3.83. The rest will be invested in stock buybacks and growth opportunities. In addition to the buybacks, Safeway returns wealth to investors through a 3.5% dividend yield, or $0.80 per share annually.

Safeway is using the money it made from selling the Canadian branch wisely, and making decisions with investors in mind. Like Kroger, it isn’t a high-growth stock, but the company consistently returns wealth to investors through dividends and share buybacks.

The market's fresh face

The Fresh Market (NASDAQ: TFM) is a specialty grocery store that offers all-natural and organic food options to shoppers who are willing to pay a premium. This premium allows Fresh Market to have higher margins than other grocery stores like the ones mentioned above. The company’s gross margin is a competitively high 35.5%.

In its most recent quarter, Fresh Market saw same-store sales and total sales increase 3% and 13%, respectively.  The increase in sales can be attributed to a 13% increase in total square footage, alongside new promotional programs.  Customer traffic also increased 60 basis points from a year earlier. This led earnings per share to increase 14.6%, from $0.40 to $0.46.

Fresh Market recently appointed Jeff Ackerman as its Executive Vice President and Chief Financial Officer after a national search. Ackerman most recently served as CFO at Sealy, one of the largest bedding manufacturers in the world. Before this, Ackerman was Vice President, Finance with Dade Behring and had different finance jobs at Frito-Lay. With over 25 years of experience working for large corporations, Ackerman will bring a valuable, operational mindset to Fresh Market.

Looking forward, Fresh Market plans to open 19 to 22 new stores this year, adding to the 131 stores it already owns in 25 states. This is a start to the company’s overall goal of having 500 domestic stores. With the organic food market growing roughly 10% a year, I see this company expanding rapidly in the future.

Conclusion

People are always going to need grocery stores, and Kroger, Safeway, and Fresh Market have all had success supplying Americans with their much-needed food. If you prefer stocks with higher growth, Fresh Market would be a good buy. Both Kroger and Safeway have good yields, but between the two, I prefer Kroger. I think it has better plans to continue expansion and increase market share in the future.  Grocery stores might not have the most exciting stocks, but they are good investments that will bring you returns over time.


Ben Popkin has no position in any stocks mentioned. The Motley Fool recommends The Fresh Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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