The Kroger Co. (NYSE: KR)
QVI Research Report | Updated Coverage | May 2023
Summary
Kroger has delivered market-beating returns after adding its value-priced shares to our family portfolio over two years ago as a defensive holding to an overheated market.
QVI downgraded the stock to hold in early 2022 based on elevated price and enterprise value to earnings ratios before upgrading to buy after a valuation recheck.
The originator of the supermarket model leverages its experience and scale to outperform direct competitors, the non-cyclical consumer sector, and the broader stock market.
On Wall Street, Kroger’s impending merger with competitor Albertsons appears more of a short-term arbitrage play than a long-term business model concern.
Therefore, in this updated research report, QVI maintains its buy rating based on a consensus bullish view of the value proposition, yields, fundamentals, valuation, and downside risks.
Premium (paying) subscribers: When referencing this research report, access your Quality Value Investing (QVI) Glossary of Investing Terms and Metric Targets. Unless noted, all data presented is sourced from Seeking Alpha Premium as of the market close on April 26, 2023, and intended for illustration only.
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The Kroger Co. Value Proposition
QVI Research Report’s value proposition section provides a brief synopsis of the company’s business model, major-exchange listing, stock symbol, market capitalization, and dividend-paying status. In addition, it defines the competitive advantages of a company’s products or services to its customers compared to the industry, including the stock’s historical performance vs. the sector and market.
The Kroger Co. (NYSE: KR) is a dividend-paying large-cap stock in the consumer staples sector’s food retail industry. KR was added to the QVI Concentrated Portfolio on February 18, 2020, at a split and dividend-adjusted $27.95 a share.
The Kroger Co. operates as a food and drug retailer in the United States. The company operates combination food and drug stores, multi-department stores, marketplace stores, and price-impact warehouses. Its combination food and drug stores offer natural food and organic sections, pharmacies, general merchandise, pet centers, fresh seafood, and organic produce; and multi-department stores provide apparel, home fashion and furnishings, outdoor living, electronics, automotive products, and toys.
The company’s marketplace stores offer full-service grocery, pharmacy, health and beauty care, and perishable goods, as well as general merchandise, including apparel, home goods, and toys; and price impact warehouse stores provide grocery, and health and beauty care items, as well as meat, dairy, baked goods, and fresh produce items. It also manufactures and processes food products for sale in its supermarkets and online; and sells fuel through fuel centers.
The Kroger Co. was founded in 1883 and is based in Cincinnati, Ohio, USA.
QVI’s value proposition elevator pitch for Kroger:
The originator of the supermarket model leverages its experience and scale to outperform direct competitors, the non-cyclical consumer sector, and the broader stock market.
Performance vs. Sector and Market
The chart below illustrates KR’s performance against the Consumer Staples Select Sector SPDR® Fund ETF (NYSE: XLP) and the SPDR® S&P 500 ETF Trust (NYSE: SPY) since QVI’s initial coverage of Kroger in February 2020.
For example, KR has outperformed its sector and the broader market in total returns by over 4,200 basis points (bps) during the coverage timeframe.
Due Diligence Resources
For a more in-depth analysis of the all-important value proposition, visit The Kroger Co.’s investor relations webpage and its most recent Form 10-K Annual Report submitted to the U.S. Securities and Exchange Commission or SEC.
QVI’s value proposition rating for The Kroger Co.: Bullish.
KR Total Returns vs. XLP and SPY
The Kroger Co (KR) Total Return: 71.65%
Consumer Staples Select Sector SPDR ETF (XLP) TR: 29.22%
SPDR S&P 500 ETF Trust (SPY) Total Return: 27.06%
Since February 18, 2020 (as of April 26, 2023)KR Shareholder Yields
QVI Research Report’s shareholder yields section uncovers the equity bond rate of the company’s common shares. It aims to quantify the yields on earnings, free cash flow, and dividends to measure how the targeted stock compares to the prevailing yield on the 10-Year Treasury benchmark note.
Earnings and Free Cash Flow Yields
KR’s earnings yield traded above the QVI targeted floor at 6.42%, as demonstrated in the below chart. On the contrary, at 4.09%, KR’s free cash flow yield traded under the threshold.
As inverse valuation multiples, the weighted earnings and free cash flow yields suggest that KR trades at a fair price. QVI will further explore valuation multiples later in this report.
Dividend Yield
The Kroger Co. offers a modest forward dividend yield of 2.07%, supported by a conservative 23.46% payout ratio, thus indicating a safe dividend rate with room for additional annual increases.
KR yielded 3.72% from an annual payout of $1.04 on a split- and dividend-adjusted cost basis of $27.95 per share on February 18, 2020, the date of QVI’s initial stock coverage. Thus, our yield-on-cost basis was +165 bps above the forward yield.
Average of Shareholder Yields
Quality Value Investing takes the average of the three shareholder yields to measure how the stock compares to the prevailing yield of 3.45% on the 10-Year Treasury benchmark note. For example, the average shareholder yield for KR was 4.19% or +74 bps above the 10-Year and 4.74% or +129 bps above the Treasury yield when using QVI’s February 2020 yield-on-cost basis.
QVI’s shareholder yields rating for KR: Bullish.
KR Shareholder Yields
The Kroger Co (KR) Price: $47.83
The Kroger Co (KR) Earnings Yield: 6.42%
The Kroger Co (KR) Free Cash Flow Yield: 4.09%
The Kroger Co (KR) Dividend Yield: 2.07%
One-Year Trailing (as of April 26, 2023)The Kroger Co. Fundamentals
QVI Research Report’s fundamentals section measures the performance strength of the company’s senior management by analyzing revenue growth, net profit margin, and returns on equity and invested capital.
Revenue Growth and Net Profit Margin
Per the below chart, The Kroger Co. had positive three-year annualized revenue growth of 6.63%, underperforming the 10.54% median growth of the consumer staples sector.
Farther down the income statement, Kroger had a trailing three-year low single-digit net profit margin of 1.58%, typical of a retailer; however, it underperformed the sector’s median net margin of 3.55%.
Returns on Equity and Invested Capital
The Kroger Co.’s management produced a trailing three-year return on equity or ROE of 24.47%, beating the targeted threshold and doubling the sector’s median ROE of 10.57%.
Stock buyback programs often elevate ROE. In March, Kroger Co.’s board of directors paused stock buybacks to prioritize deleveraging following its proposed merger with Albertsons (NYSE: ACI)
At 10.35%, Kroger’s three-year return on invested capital, or ROIC, is below the QVI threshold but outperforms the sector’s median ROIC of 6.42%, indicating that its senior executives are above-average capital allocators.
In addition, Kroger’s ROIC doubles its weighted average cost of capital, or WACC, of 5.40%. (Source of WACC: GuruFocus).
Despite low single-digit profit margins — typical of a large food retailer — and acquisition-related stock buyback pause, their positive revenue growth, robust returns on equity, and sector-beating returns on invested capital suggest that Kroger’s management continues its long history of 2nd level performance in Cincinnati.
QVI’s fundamentals rating for The Kroger Co.: Bullish.
KR Returns on Management
The Kroger Co (KR) Revenue Growth (3y CAGR): 6.63%
The Kroger Co (KR) Profit Margin (3y Median): 1.58%
The Kroger Co (KR) ROE (3y Median): 24.47%
The Kroger Co (KR) ROIC (3y Median): 10.35%
Three-Year Trailing (as of April 26, 2023)KR Valuation, Risks, and Investment Thesis
Next, QVI dives into the valuation multiples, downside risks, and overall investment thesis of The Kroger Co. (KR), including potential catalysts. So let’s dig further after reading the required disclosures and background information.
Disclosure: I/we have a beneficial long position through direct ownership of KR common shares in our family portfolio. I wrote this post myself, and it expresses my own opinions. I am not receiving compensation for it other than from Substack paid subscriptions. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Quality Value Investing by David J. Waldron’s primary ticker research reports are for informational purposes only. The accuracy of the data cannot be guaranteed. Narrative and analytics are impersonal, i.e., not tailored to individual needs nor intended for portfolio construction beyond his family portfolio, which is presented solely for educational purposes. David is an individual investor and author, not an investment adviser. Readers should always engage in their own research or due diligence and consider (as appropriate) consulting a fee-only certified financial planner, licensed discount broker/dealer, flat fee registered investment adviser, certified public accountant, or specialized attorney before making any investment, income tax, or estate planning decisions.
About the Writer
David J. Waldron is contributing editor of Quality Value Investing and author of the international-selling book, Build Wealth with Common Stocks: Market-Beating Strategies for the Individual Investor. David’s mission is to inspire the achievement of his readers’ financial goals and dreams. He received a Bachelor of Science in business studies as a Garden State Scholar at Stockton University and completed The Practice of Management Program at Brown University. David and his wife, Suzan, reside in historic South Central Pennsylvania, USA.
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