Is This Traditional Grocer Becoming Less Traditional?

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Last Thursday, Kroger (NYSE: KR) reported strong fourth quarter earnings and fiscal year 2012 results that continue to point to the retailers ability to adapt and remain profitable in a traditionally low margin industry. In the fourth quarter, the company delivered 3.0% comparable store growth (excluding gasoline) and earnings per share that exceeded guidance by $.07 per share. These earnings come in the wake of a string of disappointing earnings results from both traditional and specialty retailers.

Both Whole Foods Market (NASDAQ: WFM) and The Fresh Market (NASDAQ: TFM) recently reported weaker than expected sales growth, while Safeway (NYSE: SWY) continues to struggle in achieving profitable growth. This is Kroger's 37th consecutive quarter of comparable store growth, but the more impressive attribute of Kroger has been its ability to drive profit in the wake of rising competition and an increasingly frugal and fickle consumer. Kroger's chairman and CEO David Dillon stated: 

Our associates delivered an outstanding year that underscores how our growing connection with customers remains the key to shareholder value creation. Kroger's unique value offering of better service, great products and an enjoyable shopping experience with low prices continues to resonate with a full range of customers. 

Perhaps more impressive than the company's ability to grow earnings and revenue in tandem in fiscal year 2012 is the company's guidance for fiscal year 2013. Dillon outlined that Kroger is expecting to achieve comparable store growth between 2.5% and 3.5% along with an 8-11% increase in earnings, year over year. This type of growth is not characteristic of traditional grocers and points to Kroger's ability to control costs, innovate its stores to compete on price and variety, and ultimately provide investors with a stable business model that is poised for moderate future growth. 

For investors, Kroger's strength points to a retailer that is adapting to a changing environment and consumer. The strategy that Kroger has embarked upon is one that makes its traditional supermarket more competitive against its largest competitors: other grocers, specialty grocers, along with general merchandisers such as Wal-Mart and Target.

To combat specialty grocers, Kroger and other grocers have begun to carry more natural and organic products along with focusing more on environmentally friendly products and practices. The Fresh Market reported fourth quarter earnings on Wednesday to investors dismay (the stock plunged 10%) in the wake of shrinking comparable store growth. Whole Foods Market is facing a similar situation. This is in large part a result of retailers like Kroger and other traditional grocers adapting their stores to offer more specialty products. Kroger has also taken on mass merchandisers like Wal Mart and Target by investing into pricing, but also expanding its offerings into clothing in some stores to begin diversifying its offerings to consumers. What is important for investors is that Kroger has been able to make these innovations, while simultaneously keeping costs low and thus driving profitable growth. 

From a valuation perspective, Kroger is priced fairly for investors when compared to its peer group and the specialty retailers aforementioned.

Forward Price/Earnings: 11.50

  • SWY: 9.98
  • TFM: 19.03
  • WFM: 25.28

PEG Ratio: 1.22

  • SWY: .87
  • TFM: 1.09
  • WFM: 1.60
EV/EBIDA: 5.70
  • SWY: 4.85
  • TFM: 15.21
  • WFM: 13.38
Quarterly Earnings Growth: 61.70% 
  • SWY: 13.20%
  • TFM: 19.00% 
  • WFM: 23.70%

Although Kroger is "more expensive" than Safeway in terms of its forward price/earnings and its PEG ratio, it is also a more stable and profitable company. This warrants a premium over Safeway. In terms of the company's valuation in terms of Whole Foods Market and The Fresh Market, Kroger is far cheaper by most accounts of valuation. For investors, this means a company that is priced well and is achieving both revenue and earnings growth. 

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KR data by YCharts

Through Kroger's innovation, attention to cost savings, and ability to connect with customers, it has been able to achieve 37 consecutive quarters of comparable store growth. In the wake of rising competition and a changing consumer, Kroger has illustrated its ability to drive profitability and compete in the changing marketplace. Though Kroger is a traditional grocer, the company is becoming less traditional in the sense of price control, EPS growth, and reasonable valuation. 

Justin Weinstein has no position in any stocks mentioned. Justin Weinstein is not recommending a position in any stock aforementioned. The Motley Fool recommends The Fresh Market and Whole Foods Market. The Motley Fool owns shares of Whole Foods 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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