Why This Grocer Can Still Grow Your Greenbacks

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

Grocery store chain Kroger's (NYSE: KR) stock has been on a rally recently for several reasons. It continues to beat analysts' expectations. It's growing at the high range of management forecasts. It's expanding same-store sales. It has a strong and thriving pharmacy business. It's cheap when compared to other retailers. And Kroger continues to reward shareholders with a growing dividend. But have its shares rallied too much, or is there still grow for the stock to grow?

Earnings beat
Kroger beat top- and bottom-line estimates once again in its most recent quarter, posting revenue of $24.2 billion (versus $24.01 billion expected) and EPS of $0.77 (versus $0.70 expected).

Kroger grew its revenue by 13%, and went from a large loss last year due to pension costs, to posting a net gain of $461.5 million.

Kroger is well on its way to maintain its 8%-12% EPS growth rate (I would guide towards 11%-12% EPS growth) and 10% revenue growth rate.

Management is guiding that same-supermarket sales (excluding fuel) will grow by 2.5%-3.5% in 2013. In Kroger's latest quarter they saw 3% identical supermarket sales growth, versus 0.8% for rival Safeway (NYSE: SWY)  and 1% for Wal-Mart Stores Inc (NYSE: WMT).

Two quarters ago, I recommended buying shares of Kroger before earnings. Since then, Kroger has gone from $22 a share to $31today. Over the past nine quarters, Kroger has beaten every earnings estimate, with an average beat of just over 5%. This continuous outperformance provides one reason to be bullish on Kroger, since it means there could be hidden value in the stock that isn't realized until earnings are released.

Why Is Kroger Outperforming?

Kroger is seeing strong-same store sales for several reasons.

First, when Walgreen and Express Scripts "split up" briefly back in 2012, many consumers with prescription drug needs went to Kroger stores to get them filled. This was a big deal, because Walgreens and Express Scripts controlled 21% of the pharmacy market in 2011. 

Kroger has been aggressively trying to get a larger share of consumers' prescriptions. In November 2012, Kroger purchased the specialty pharmacy company Axium to get into its rapidly growing  market. Specialty drugs used to represent 9% of Kroger's total pharmacy revenues in 2006, but has since jumped to 17% in 2011. Kroger is using its newfound "sticky" revenue from consumers with prescription drug needs to fuel its growth.

It also revamped its customer rewards program a few years back,which continues to resonate well with consumers. Kroger offers a rewards program where customers earn points for each dollar they spend at its stores. Once they reach a certain amount, they can turn those points into cash.

This is a strong driving force to ges customers back into Kroger's stores, because if someone is almost about to earn $25, they're far more likely to go shop at Kroger than somewhere else.

Together, these two initiatives have boosted same-stores sales, and thus, the bottom line.     

The Competition and Statistics

Kroger trades at a PE of 11.25, versus an industry average of 16.55. Safeway trades at a PE of 10 and is expected to grow at a slower rate than Kroger, while gigantic Wal-Mart trades at a PE of 14.7 and is also expected to grow a slower rate.

Both Wal-Mart and Safeway are seeing smaller same-store sales gains, yet trade at similar PE levels as Kroger. This means that Kroger's cheaply valued relative to other stocks; if it only grew to equal Wal-Mart's P/E, investors would still enjoy another 30% upside. 

Balance Sheet and Dividend

Kroger does have a significant amount of debt versus its cash, but that is common for retailers. As of its latest quarter, Kroger had $1.2 billion in cash and $6.18 billion in total long term debt.

The company pays a dividend of $0.15 per share, for a 1.95% yield. That payout's up from the $0.12 per share it paid out a year earlier.  And with a current payout ratio of only 17.81%, Kroger's management has ample room to boost the dividend further. Going forward, I expect Kroger to to increase its dividend by another $0.03 per share within the next year.

If you are a long-term investor Kroger is a great stock to own. It pays out a steady dividend, can easily manage to pay the dividend, and could continuously increase that dividend for decades to come. Starting at $0.065 per share in 2006, Kroger's hiked its dividend every single year since, even through the recession of 2008 and 2009. That is a very bullish sign of a good company.

Final Thoughts

Even after Kroger shares' recent run, the stock still looks like a buy. It continues to outperform, trades at cheaper ratios than the industry, has a promising future in the pharmacy business, continues to boost its dividend, and would be a great long-term pick for any portfolio.

Any company that has enough faith in its business to boost its dividend while the global economy goes through a massive recession is worth looking into. I think that Kroger will beat expectations going forward, just as it has done in the past.

One thing to look out for is the effect of the recent payroll tax increase on customers' shopping budgets, but bullish jobs data should keep mitigate that risk. Stronger-than-expected retail data for February should also help Kroger. All in all, I'm still bullish on this grocery store.

Callum Turcan has no position in any stocks mentioned. The Motley Fool recommends Express Scripts. The Motley Fool owns shares of Express Scripts. 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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