A 32% Potential Upside for This Grocery Retailer

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

Kroger (NYSE: KR) has advanced significantly since the beginning of the year, with stock prices going from around $26 per share to nearly $34 per share. In the company's recent first quarter earnings announcement, it also reported a good growth in bottom line. Is Kroger a good choice for investors’ portfolios after this announcement? Let’s take a look.

Impressive first quarter earnings

In the first quarter 2013, Kroger managed to grow both its revenue and net income. The revenue increased from more than $29 billion last year to $30 billion this year. Net income rose by more than 9.5% to $481 million. Interestingly, its earnings per share experienced a higher growth of more than 19%, from $0.78 per share to $0.93 per share. The higher growth in earnings per share was due to the share buyback activities during the past twelve months. The company reported that during the past four quarters, it has returned more than $1.3 billion to shareholders through both dividends and share buybacks.

Based on the positive momentum of the good first quarter results, Kroger raised its 2013 earnings-per-share guidance from $2.71 to $2.79 per share to $2.73 to $2.80 per share. Including increasing dividends, its long-term growth rate guidance stayed in the range of 8% to 11%. David Dillon, the company’s chairman and CEO felt proud, saying that “The Kroger team's relentless focus on delivering on our Customer 1st strategy, quarter after quarter, continues to set us apart. We will continue to build on this strong momentum to drive growth and greater shareholder value.”

The cheapest valued company with good profitability

Kroger is currently trading at $34 per share, with the total market cap of $17.50 billion. The market values Kroger only at nearly 5.6 times its trailing EBITDA (Earnings before interest, taxes, depreciation and amortization). Compared to its much bigger peers including Target (NYSE: TGT) and Wal-Mart (NYSE: WMT), Kroger is definitely quite cheap.

Target, at $68 per share, is worth around $43.8 billion on the market. The market values Target at 7.4 times its trailing EBITDA. Despite the higher earnings valuation, Target’s revenue and profit decreased in the first quarter 2013.Its revenue came in at $16.7 billion, a bit lower than $16.87 billion in revenue last year, but its earnings per share declined from $1.04 per share in the first quarter of 2012 to $0.77 per share this year. For the full year, the company estimated that it would generate around $4.12 to $4.32 in earnings per share.

Wal-Mart is the most expensively valued among the three companies. It is currently trading at $74.20 per share, with the total market cap of more than $243.1 billion. The market values Wal-Mart at more than 7.9 times its trailing EBITDA. Wal-Mart also did not have an impressive first quarter earnings results. While its revenue moved up by only 1% to $114.19 billion, its net income increased by 1.1% to $3.78 billion, or $1.15 per share. In the first quarter, Wal-Mart returned around $3.8 billion to shareholders, including $2.2 billion in share repurchases and $1.6 billion in dividends. In the second quarter, company CFO Charles Holley commented that Wal-Mart expected to produce around $1.22 to $1.27 earnings per share in the second quarter of fiscal 2013.

Wal-Mart seems to deserve a higher valuation due to its higher ROIC (return on invested capital) at 12.34%. Kroger ranked second with nearly 9.5% ROIC, while the ROIC of Target was the lowest, at only 6.28%. Income investors might also like Wal-Mart the best with the highest dividend yield at 2.6%. Target offers investors a bit lower dividend yield at 2.5%, whereas the dividend yield of Kroger is much lower, at only 1.8%. Interestingly, the low dividend yield of Kroger was due to the more conservative dividend policy with lower payout ratio. While the payout ratios of Wal-Mart and Target are 33% and 32%, respectively, Kroger only pays 18% of its earnings in dividends. If Kroger increased its payout ratio to 32%, its dividend yield could reach 3.2%.

Kroger could be worth $45 per share

Kroger seems to be a good stock for long-term investors at its current price, due to the lowest valuation, recent impressive quarterly earnings results and a decent profitability. Moreover, Kroger could easily increase its payout ratio equivalent to the payout ratio of Target or Wal-Mart, pushing up the dividend yield. If an EBITDA multiple of 7.5 is applied to Kroger, it should be worth more than $45 per share.

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Anh HOANG has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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