Do These Stocks Belong on Your Grocery List?

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

When thinking about where you want to buy your food, the first consideration has to be quality. Nobody wants to buy rancid meat or moldy bread. Thankfully quality standards for food are pretty high in this country, and supermarkets almost never have spoiled food on their shelves.

After quality, the second biggest factor for practically everyone is price. You want to be sure you're receiving the most bang for your buck whenever you buy anything, especially food.

Because there are so many options for Americans out there, purveyors of foodstuffs aggressively try to keep prices low in order to entice customers. The grocery store business is notoriously a low-margin one.

Even so, just because a business operates in a low margin environment doesn't necessarily make it a bad investment. I wanted to examine and compare three large supermarket chains to see if any of them seem like an attractive buy.

A safe place to invest?

Safeway (NYSE: SWY) is the second largest supermarket chain by revenues in the United States, although it is utterly dwarfed by the company in the number one spot.

The company operates 1,641 stores primarily in the western and mid-Atlantic states. The market is currently offering to sell Safeway to investors for $5.9 billion dollars--how fair is that price?

To answer that let's first look at the balance sheet. Safeway has a narrow working capital deficit and shareholder's equity of approximately $3 billion.

Between 2007 and 2012 Safeway nearly halved its amount of outstanding diluted shares. Diluted shares outstanding represent the amount of shares that would exist if holders of the company's warrants, and other convertibles, exercised their privileges. 

Safeway has generated, on average, $314.2 million in net income between 2008-2012. In the five years before that average net income was $542.1 million.

The main reason the average was so much lower in the more recent 5 year span was because the company took a write down on its goodwill of nearly $2 billion in 2009. Don't worry, that's something that couldn't happen again, seeing as how the company now has less than $500 million worth of goodwill on its balance sheet.

Safeway's dividend yield of 3.2% is the highest of these three supermarket stocks. The company has never lowered its distributions since they began in 2005. During that time distributions grew at a CAGR of 18.9%.

All in all Safeway doesn't seem like a bad investment at current prices.

But this supermarket stock does

There are multiple reasons why I don't want to buy any stock in  SuperValu (NYSE: SVU) right now. The company has a working capital deficit of $1.3 billion, or over 70% of its market cap. Stockholder's equity is currently negative $1.4 billion. 

The company has recorded net losses of over $1 billion in four out of the past five years. The company's dividends paid per share were 87.3% lower in 2013 than in 2009. Supervalu seems like a pretty poor investment right now.

The company did just appoint a new management team, so some investors might see this as a turnaround opportunity. The odds of that happening seem miniscule at best, though, as reversing half a decade's worth of massive losses is not an easy thing to do.

Our nation's biggest supermarket chain

Kroger (NYSE: KR) has a market cap of $19.5 billion. Kroger too has bought back shares in recent years, reducing its diluted shares outstanding by 15.8% between 2010 and 2012.

The company currently pays a 1.6% dividend with a low payout ratio of 18%. Kroger started paying a dividend in 2006, and since then has grown distributions at a CAGR of 12.7%.

The company recently expanded its store count in southeastern and mid-Atlantic states through an acquisition of Harris Teeter. Kroger paid $2.44 billion in exchange for 212 stores that are in fairly good shape.

Foolish final take

Supermarkets are businesses with notoriously low margins. All three of these supermarket chains face intense competition. In addition to having to compete with the likes of Wal-Mart, Amazon is trying to dominate the grocery market as well. 

Of these three companies SuperValu seems like the worst investment by far. Its profits are non-existent and its balance sheet is weak. Perhaps new management may be able to breathe some life into this company, but I wouldn't bet on it.

Then there's Safeway and Kroger. Neither of these companies is likely to be a multi-bagger in the near future, but both company's are solid profit producers nonetheless.

Personally, I like Safeway more. Its dividend is the more attractive of the two and it is much cheaper on a price to book basis. Finally, while Kroger hasn't been stingy about buying back its own shares in recent years, Safeway has been better.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.

Ryan Palmer has no position in any stocks mentioned. The Motley Fool owns shares of Supervalu. 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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