7 Reasons to Buy Kroger Calls (KR)

by Ian Harvey | September 11, 2013 9:10 am

Because of the overseas problems, particularly with Syria, it is always good to see a domestic play with high growth, and The Kroger Co. (KR[1]) certainly fits the description, especially with its focus on private label items.

Also, with the recently weak nonfarm payrolls report released last week, investors have started to shift back into pharmaceuticals and supermarkets. And despite competing in an intense industry where margins are razor-thin, Kroger has emerged a market leader.

This grocery chain will be reporting second quarter results before the market opens September 12. Along with an expected earnings report of merit, combined with good technicals, a nice steady upward movement in share price (despite the slight pullback in August), good management and steady expansion, great reviews from hedge-fund managers as well as analysts, all add up to a profitable trade using an options call.

Let’s now look further at the positive factors associated with Kroger:

1. Earnings Expectations Look Good — Wall Street is optimistic about Kroger, which is slated to report its second quarter results on Thursday, September 12, 2013. Analysts project a profit of 60 cents a share, a rise from 51 cents per share a year ago.

Analysts are expecting earnings of $2.80 per share for the fiscal year. Revenue is projected to be 4% above the year-earlier total of $21.73 billion at $22.67 billion for the quarter. For the year, revenue is projected to come in at $99.07 billion.

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Over the last four quarters, the company has seen its revenue grow by an average of 7% year-over-year. The 38% increase in the most recent quarter was the biggest rise.

Also of interest, KR has bested analysts’ bottom-line expectations in all of the last eight periods, with an average positive earnings surprise of 5 cents per share. What’s more, the stock has tacked on an average of 0.5% the day after the report, and 2.9% the following week.

2. Good Technicals – KR was recently trading at $37.35 intraday, down $2.63 from its 12-month high of $39.98 and just $16.89 above its 12-month low of $23.09.  The stock’s 50-day moving average is currently $37.96. The company has a market cap of $19.691 billion and a price-to-earnings ratio of 13.01.

Technical indicators for KR are neutral and the stock is in a weak upward trend. The stock has support above $36.50.

Also, The Kroger Co. is currently trading at 12 times earnings, making it cheap compared to peers.

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3. Steady Upward Trending – After a very strong first half of the year, Kroger stock ran into some selling pressure through August, but appears to have found support and has begun to move in the right direction. Even with the August sell off; the stock is up 45.5% year to date.

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4. Capable Management – Kroger’s “Customer 1st” strategy successfully ties its fuel centers into its loyalty program, rewarding customers who shop at its stores with discounts on gasoline. The company is also renovating and redesigning many of its stores, giving them a more upscale look, adding wine departments made to look and feel like a wine shop, adding more upscale deli offerings as well as sushi counters in many of its stores, and also increasing its natural and organic food offerings, even starting its own successful organic brand, Simple Truth. All of these tactics are smart management strategies.

Kroger has taken on a transformation that has it competing more with Whole Foods (WFM[5]) than with Wal-Mart (WMT[6]). That’s a smart choice by management since going head-to-head with Wal-Mart can be a difficult task.

Management is predicting long-term earnings growth of 8%-11%. That alone would be a solid return, but factor in the dividend and Kroger should continue to be a solid company going forward.

5. Continued Expansion — The Kroger Co. is focused on store-based expansion and it wants to target the high-end consumer.

Kroger Co. recently acquired Harris Teeter (HTSI[7]) to accomplish the latter, as the majority of these supermarkets are located in high-end areas. Not only that, but these are areas where The Kroger Co. doesn’t yet have exposure.

6. Hedge Funds Swamping Kroger — In preparation for the third quarter, there has been an increase of 26% hedge funds tracking Kroger since the first quarter. With hedge funds’ sentiment swirling, there exists an “upper tier” of noteworthy hedge fund managers who were increasing their stakes substantially.

There are several particular hedge funds that have jumped into Kroger headfirst. East Side Capital (RR Partners), managed by Steven Richman, assembled the most outsized position with $195.9 million invested in the company at the end of the quarter. Arrowstreet Capital also initiated a $73.5 million position during the quarter. The following funds were also among the new KR investors: AQR Capital Management, Adage Capital Management and D. E. Shaw.

7. Backing from Analysts – The majority of analysts (60%) rate Kroger as a buy. This compares favorably to the analyst ratings of nine similar companies, which average 35% buy ratings.

Analysts at the TheStreet reiterated KR’s “buy” rating and wrote:

“Kroger (KR) has been reiterated by TheStreet Ratings as a buy with a ratings score of A. The company’s strengths can be seen in multiple areas, such as its solid stock price performance, impressive record of earnings per share growth, increase in net income, revenue growth and notable return on equity. We feel these strengths outweigh the fact that the company has had generally high debt management risk by most measures that we evaluated.”

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Recommendation

Expect to see positive numbers from Kroger for its second quarter. It had a good first quarter, during which it earned $0.92 per share, well ahead of the $0.88 analysts were expecting. It did slightly miss its revenue forecast, but only by 0.53%. Following its first quarter, the company noted that its “Customer 1st” strategy was working, and thus it raised its full-year guidance to a range of $2.73 to $2.80 per share from its previous forecast of $2.71 to $2.79. The stock traded higher in the six weeks following its last earnings report, but has run into some selling pressure over the last month. Expect to see another strong quarterly report, which should help the stock make back some of its recent losses.

Having a dominant position among the nation’s largest grocery retailers enables Kroger to sustain growth in both its top and bottom line, expand its store base, and boost its market share. The company’s strong corporate and national brands helped it gain customer loyalty. These factors, along with those listed above, make for a very positive 60% profit.

Therefore, take advantage of the following options call:

OPTIONS TRADE: Buy the KR Jan 2014 40.000 call (KR140118C00040000[9]) at or under $1.05, good for the day. Place a protective stop limit at $0.45 and a pre-determined sell at $1.70.

Visit stock-options-made-easy.com[10] for a wealth of information that will help you benefit from the exciting and lucrative world of options trading.

 

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