Browsing the Shelves for a Grocery Stock

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Which grocery company is the most attractive to investors? Wal-Mart and Costco are the first major grocery stores that come to mind. But are the most popular companies always the best investment? Kroger (NYSE: KR), Safeway (NYSE: SWY), and Whole Foods Market (NASDAQ: WFM) offer alternative investment options in the grocery stores industry.

<table> <thead> <tr><th> </th><th> <p><strong>Market Cap</strong></p> </th><th> <p><strong>2012 Revenue</strong></p> </th><th> <p><strong>2012 Net Income</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>Kroger</strong></p> </td> <td> <p>$16.38 billion</p> </td> <td> <p>$90.3 billion</p> </td> <td> <p>$602 million</p> </td> </tr> <tr> <td> <p><strong>Safeway</strong></p> </td> <td> <p>$5.99 billion</p> </td> <td> <p>$44.2 billion</p> </td> <td> <p>$596 million</p> </td> </tr> <tr> <td> <p><strong>Whole Foods </strong></p> </td> <td> <p>$15.99 billion</p> </td> <td> <p>$11.6 billion</p> </td> <td> <p>$465 million</p> </td> </tr> </tbody> </table>


The Kroger Company

Kroger operates 3,226 supermarkets and convenience stores in the United States. In addition to being a retailer of grocery foods, it has its own private brand label for sale in its stores. It is the largest of these three stores with the highest market cap, revenue in 2012, and net income. It also owns 348 fine jewelry stores in the United States.

In the most recent quarter, Kroger’s revenue grew by 13%. It has made major efforts in increasing customer experience with its customer rewards program. This has attracted more returning and new customers to its stores. Next quarter, the company should be able to continue this growth with an expected increase in earnings.

Safeway

Like Kroger, Safeway owns and operates grocery stores and carries its own private label brand. As of December 2012, it had 1,641 stores in North America. Its popular private label brands are Lucerne, Safeway Select, and Pantry Essentials. This company also profited from a loyalty and rewards program. 45% of its revenue in the most recent quarter came from customers who were enrolled in the loyalty program.

Whole Foods Market

Whole Foods differs from these two companies in that it focuses on a niche market -- organic and natural foods. Also, it operates stores outside of the United States in Canada and the United Kingdom. As of February 2013, the company owned and operated 340 stores. It has considerably fewer stores than the other companies, and its revenue reflects the difference.

Its focus on organic and natural foods makes it a part of a large growing trend. Its prices are noticeably higher than its competitors, but this has not pushed away any customers.

Financial overview

<img src="http://g.fool.com/editorial/images/25849/screen-shot-2013-03-20-at-93934-pm_large.png" />

The last five quarters have seen a drastic change in earnings for each of the companies. The last two quarters have shown the same basic trends for each of the companies. An interesting point to note is the level of earnings per share, when compared to total revenue and market cap. Whole Foods is considerably smaller than both Kroger and Safeway, and yet, its earnings per share are in line.

<table> <thead> <tr><th> </th><th> <p><strong>Quick Ratio</strong></p> </th><th> <p><strong>Current Ratio</strong></p> </th><th> <p><strong>Debt to Equity</strong></p> </th><th> <p><strong>Return on Equity</strong></p> </th><th> <p><strong>Return on Assets</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>Kroger</strong></p> </td> <td> <p>0.26</p> </td> <td> <p>0.72</p> </td> <td> <p>2.11</p> </td> <td> <p>36.34%</p> </td> <td> <p>6.27%</p> </td> </tr> <tr> <td> <p><strong>Safeway</strong></p> </td> <td> <p>0.35</p> </td> <td> <p>0.9</p> </td> <td> <p>1.9</p> </td> <td> <p>16.85%</p> </td> <td> <p>3.81%</p> </td> </tr> <tr> <td> <p><strong>Whole Foods </strong></p> </td> <td> <p>1.45</p> </td> <td> <p>1.85</p> </td> <td> <p>0.43</p> </td> <td> <p>14.67%</p> </td> <td> <p>10.27%</p> </td> </tr> </tbody> </table>

Margins are extremely thin for grocery stores. Price wars and rising food costs are two major factors affecting the bottom line. It is important to look at the return on equity and the return on assets. Kroger made only $600 million on $90 billion in revenue in 2012. This is a prime example of the difficulties of the grocery store industry. Management effectiveness is a necessary metric. Kroger leads the pack with its return on equity. Investors are given returns on equity invested in the company at the rate of 36%.

The only company to not have excessive debt is Whole Foods. It has fewer stores to run, but still manages a high net income. With such low margins, it is important to have operating capital and expansion capital. Whole Foods has been able to accomplish its capital needs without heavy debt.

The pick of the lot

Of these companies, Whole Foods looks the most promising. It has fewer stores than the other two, but still boasts strong revenue and solid earnings. It is the leader of the organic and natural food mainstream movement right now, and has the best liquidity and the highest economic health. As the company continues to expand stores – and it can stay out of debt – the stock price should appreciate even more. The company supports clean eating and clean investing.

At around $88 per share and a price to earnings ratio of around 33, it is the highest valued stock of the lot. While high priced, it is still the best performing grocery store. The challenge ahead for the company will be competition. Organic and natural foods are catching on – largely thanks to the market awareness of Whole Foods. It is becoming less unique every day as even small, local retailers are carrying organic foods. It is still the best company of this lot, and has proved its business model.

Earnings are expected to remain relatively flat for the next two quarters as the growth slows down. 2013 should see an increase in its overall earnings per share and a price target of $95 is reasonable. 


Austin Higgins has no position in any stocks mentioned. He is the Principal Consultant for Avant Venture Group. and focuses on building businesses through innovation, growth and investment. Read his company's blog at BuildInvestGrow.com and follow him on Twitter @Austin_Higgins

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