Buy Kroger Ahead of Earnings
Callum is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The Kroger Co (NYSE: KR) has experienced steady growth over the years, with its same store sales up 4.2% in the last quarter. Management raised guidance for the full year and seemed overall very bullish on Kroger going forward. Should you also be bullish?
Valuation and Comparison
The price to book ratio of Kroger is 2.78, which might at first seem a bit high, but it is much less than the industry average of 4.03. Wal-Mart (NYSE: WMT) trades at a book value of 3.55, and Safeway trades at a book value of 1.3. Safeway is expected to grow its EPS by 9.3% over the next few years, while Wal-Mart's EPS is expected to grow by 8.5% and Kroger's EPS is expected to grow by 10% over the same period.
While analyst estimates are just estimates and shouldn't be taken at face value, they still gauge how Wall Street expects these companies to grow and help determine if a company is overvalued or undervalued. By these metrics, Kroger seems to be fairly valued.
Tomorrow, Kroger will report its second quarter earnings during its conference call. Analysts are expecting EPS to come in at $0.49. Over the past nine quarters, Kroger has exceeded expectations eight times, missing only once in Q3 2010.
Do I think Kroger can beat expectations? Yes, yes I do. In addition to consistently doing better than Wall Street expects, both Wal-Mart and Safeway beat expectations by a little in their latest quarters. This is a very bullish sign, because if Kroger's competitors can beat earnings, then Kroger can probably as well. Target also beat earnings in its latest quarter.
Pharmacy Growth and Sticky Revenue
After Walgreen (NYSE: WAG) and Express Scripts divorced, Kroger experienced strong growth in its pharmaceutical division as many consumers who used to go to Walgreens now go to Kroger for their prescription drug needs. Not only does this help them make more money through more drug sales, they also benefit from those consumers picking up groceries when they're in the store.
In their latest conference call, management repeatedly stated that they want Kroger stores to be a one-stop shop experience. Another benefit of having Express Scripts costumers come in for their medication is that Kroger won't need to use loss leaders like milk to get more consumers come in.
Grocery stores or big box retailers will sometimes sell milk or other products at less than cost just to get people in the door. This enables Kroger to not have to resort to that, at least for the mean time. Another thing that was brought up was the stickiness of these costumers if Walgreens and Express Scripts find some sort of resolution; "on the stickiness, the real key for us is making sure that we're delivering great service to those customers that come to us". Meredith Adler from Barclays Capital said "and do you have tie-ins with your frequent shopper program and deals to create loyalty? I mean, one of Walgreen's weaknesses, in my opinion, is that they don't have a frequent shopper program. Is that something that you think helps you keep customers?". And Rodney, Kroger's COO stated "we certainly do. And you should assume that anything that you can imagine, we're trying to do those things to help improve stickiness". This ties in to several things. One, Kroger has been actively trying to change the shopping experience for its customers by asking how its customers feel shopping at their stores and what they can do to make it better. And another thing is Walgreens recently announced that it was going to offer a customer loyalty program in Arizona, because of the success other retailers have had with one. Fred Meyers program is a perfect example of a customer loyalty program gone right, and in my own personal experience, every time my mom gets enough points on the card she goes into Fred Meyers can gets some cash back. This improves the customers shopping experience, makes them happy after they have shopped there, and gives them another reason to go back into their stores. Now Walgreens and Express Scripts have gotten back together, but most aren't sure how many customers will go back to Walgreens after the fiasco. Walgreens launching a customer loyalty program could pose a small problem for Kroger, but for now it remains to be seen if Walgreens will launch this program in all of its stores. Because of Kroger's commitment to improving its customer's experience, they have a good chance of keeping its new customers. This strategy will continue to pay off for Kroger, its investors, and its customers. Also, with many blockbuster drugs going off patents soon, management sees this raising Kroger's bottom line with better margins. This is a very bullish sign coupled with the increased foot traffic and sales in its pharmacy division from Walgreens and Express Scripts having a fit.
Kroger is going to experience an increased amount of competition in its grocery sector as big box retailers like Wal-Mart continue to compete on price and as they expand their product selection and focus more on its grocery offerings. Plus, Amazon.com (NASDAQ: AMZN) is also getting into the grocery service with its Amazon Fresh grocery delivery service to your door. This will force Kroger to remain competitive on pricing and to continue its focus of making shopping at Kroger's subsidiaries, such as QFC and Fred Meyer, more enjoyable through customer loyalty programs and reward systems. Having food delivered to your door is very convenient, but most consumers what to see what they are buying first before doing so, so Amazon's delivery service will probably not be that big of a problem for Kroger and other grocery outlets. If Amazon does build out its warehouses and is able to do same day deliveries of groceries that could be a problem in certain areas a few years down the road. The biggest competition right now for Kroger is Wal-Mart building new, smaller stores specifically for groceries. Wal-Mart is very hard to compete with, but I think Kroger will be able to pull through and compete not only on quality but also on price. We have seen a trend towards organic, natural food offerings, and Kroger has been on top of the ball in getting those products on its selves. The subsidiaries of Kroger are City Market, Kroger, Dillons, Fry’s, King Soopers, QFC, Ralphs, Jay C, Food 4 Less, Fred Meyer and Smith’s, and it currently operates about 2,500 stores with about 1,100 of them having fuel stations. It also has about 750 convenience stores and 400 jewelry stores in leased locations.
I think that Kroger will beat earnings based on past performance, its current initiatives to improve the shopping experience, the strong growth in its pharmaceutical division, and the performance of its peers. If you buy before its earnings you could see some nice gains in the short-term. In the long term, this company is a safe bet, pays out a nice 2.1% dividend yield, and is poised to grow its bottom line by anywhere from 8-12% over the next several years. I'm bullish, and I may initiate a position in Kroger in the next 72 hours.
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