A Low Risk, Low Beta Stock

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

With interest rates where they are, wouldn't it be great if you could find a stock that (1) wasn't correlated with the economy and (2) offered a reasonable return (say 5% - 15%) with minimal risk?

I feel that Kroger (NYSE: KR) is that stock.  I previously wrote an article about Safeway (NYSE: SWY) here.  That article explains why I feel that Safeway – a company that is very similar to Kroger – is "A Safe Bet in This Economy."  Perhaps Kroger is a safer bet.    

For a variety of reasons, these two stocks are very comparable. They both have a dominant footprint in grocery, they both have very effective loyalty programs, they both face many of the same challenges (unions and pension obligations), and they both are focused on improving customer experience. And both stocks have Betas of less than 1 (0.36 for Kroger and 0.75 for Safeway) and fairly attractive valuations (they both trade at Forward Price to Earnings Ratios of around 9 or 10). 

They are also two stocks that the market has ignored for too long.  That said, Kroger has consistently grown both revenues and earnings – regardless of macroeconomic conditions and the operating environment – but its stock price hasn’t moved. 

Actually Kroger's stock price has declined.  In 2007 and 2008, for instance, Kroger was valued at over $30 per share, and hovered around that price even in the midst of the financial crisis!

Predictable Growth

What is amazing is that Kroger’s share price has gone down since then, despite the fact that Kroger has consistently delivered results. 

That happened for two reasons: (1) investors took their money out of the low beta, low growth stocks and put it into high beta, high growth stocks, and (2) analysts are not bullish on the sector (but a fair number of Fools are bullish on Kroger and Safeway).

One thing is clear, though – Kroger has consistently delivered!  Sure, Kroger isn’t going to grow earnings at 20% a year, but you can count on Kroger to grow revenues and earnings at a solid 5% – 10% every year.

Kroger’s same store sales, for example, have increased for 36 consecutive quarters!  And Kroger is poised to deliver earnings growth of around 8%.  Plus, Kroger has a very effective private label strategy, which accounts for more than a quarter of its sales.

In addition to sales and revenue growth, Kroger is committed to rewarding shareholders by increasing its dividend.  Kroger recently raised its dividend by 30% and indicated that it plans to increase its dividend every year going forward.    

What Are Kroger’s Challenges?

On the positive side, deflation in produce and seafood appears to have offset inflation in other areas.  That said, cost inflation and volatility are still significant concerns.  Another challenge is maintaining share leadership.  Like many other companies, Kroger wants to be either #1 or #2 in all of its markets.  Kroger may have temporarily benefited from the Express Scripts fiasco, but Walgreen and CVS still dominate that market (Kroger is 5th in the United States).

At face value, Kroger and Safeway may have benefited from consolidation in the grocery business, which has resulted in companies such as Kroger and Safeway getting bigger and more powerful. They are both, however, both facing competition from a relative newcomer, Whole Foods (NASDAQ: WFM), which went public not too long ago – 1992, to be precise. 

Even though Whole Foods is arguably more of a niche player, it has demonstrated the ability to grow both earnings and revenues at a very high rate.  Admittedly, Whole Foods has a great corporate culture, a strong brand, and a management team that is passionate about delivering healthy products to the consumer rather than making a quick buck.

But I feel that these three companies – Whole Foods, Kroger, and Safeway – can peacefully coexist.  After all, Whole Foods is targeting a different consumer base and its products are distinct.    And, of course, unions and pension plans will always be a challenge for companies such as Kroger and Safeway, whereas Whole Foods will likely continue to be criticized for its various anti-union positions and may eventually cede to pressures to unionize. Whole Foods' previous CEO, John Mackey, for instance, made it very clear that he believes that unions create an adversarial relationship between management and labor. 

Three Reasons to Consider Buying Kroger

  1. Scale.   Kroger has negotiating power, strategic partnerships that focus on creating joint value (Starbucks and Fifth Third Bank), the ability to invest capital in store improvements, the opportunity to experiment with different store designs, and the tools to compete with any grocery store in the world on price.
  2. Customer Experience.  Inside a Kroger it is not uncommon to find a pharmacy, a Fifth Third Bank, a Starbucks, and even a section of the store dedicated to a latest trend such as healthy eating.  Kroger also has a very effective loyalty program that allows Kroger to reward loyal customers, trigger impulse purchases, generate awareness and trial of new products, increase consumers’ basket size and frequency of trips, and maximize consumers’ willingness to pay.     
  3. Private Label.  Kroger delivers value to its consumers through its private label brands.  Often times Kroger will place private label “commodity type products” right next to higher priced brands, which makes the high margin private label brand all that more enticing.  Kroger also has the opportunity to leverage its in store marketing to attract value conscious consumers to its private label brands.

My Foolish Take

On one hand, some analysts and investors will continue to dislike the sector because of its low margins.  Some will even say that we are going to see the death of the grocery store – similar to what they say about PCs.  And they will continue to tout Whole Foods, a company that seems priced to perfection because of its better margins and growth potential. 

On the other hand, you cannot ignore Kroger’s results, scale, consistent performance, and valuation.  You also cannot ignore Kroger’s commitment to improving customer experience, returning money to its shareholders, and effective use of information technology.

Overall, I feel that Kroger is a good choice for an investor who is seeking a modest returns (5% – 15% annually) with minimal downside risk. 

RyanPeckyno is long Safeway and Kroger. The Motley Fool recommends 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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