Should You Buy Kroger Stock? 3 Pros, 3 Cons

Barron’s senior editor Robyn Goldwyn Blumenthal recently made a very strong endorsement for buying Kroger (KR) stock. In her opinion, the No. 2 food retailer in the U.S. has the potential to gain 20% over the next 12 months.

Kroger KR stock to buyThe grocery business is undergoing a lot of change at the moment — Whole Foods (WFM) experimenting with lower prices; Safeway (SWY) merging with Albertson’s — and Blumenthal believes Kroger stock stands to benefit from this uncertainty.

KR definitely is firing on all cylinders at the moment. But, like every company, it has its weaknesses. The question is whether these are enough to derail the company.

So, should you buy Kroger stock? We’ll look at three pros and three cons to decide.

Kroger Stock Pros

Identical Supermarket Sales Growth: When I read that KR had 43 consecutive quarters of same-store sales growth, I immediately had to check its Q2 earnings report to verify this fact. It’s not that I doubted the seasoned writer. It’s just that it’s such an amazing feat, given the nature of the grocery business, that you have to do a double take. While inflation put some added pop in sales — 2.8% in Q2 — that still left 2% real growth year-over-year. It’s an accomplishment regardless of inflation, and it’s certainly great news for Kroger stock.

Upped 2014 Earnings: Included in Kroger’s Q2 earnings was a projected increase in fiscal 2014 earnings per share by 3 cents on the low end (to $3.22) and a penny on the high end (to $3.28). Long-term, Kroger expects to grow net earnings per diluted share by 8%-11%, with the dividend growing alongside those earnings. Keep in mind that about 75% of this growth is a result of share repurchases made in the past few years. Nonetheless, 2.3% year-over-year earnings growth (before taxes) is nothing to sneeze at in the grocery business. Once Kroger has a full year with Harris Teeter under its belt, it should be able to increase this number. Acquisition: In August, Kroger completed its $280 million acquisition. The move provides the company with the e-commerce platform necessary to take Kroger’s online business to the next level. Combined with Harris Teeter’s excellent click and collect program, Kroger has put in place the necessary pieces to leverage its loyal customer base and deliver even stronger top- and bottom-line results, which should definitely help push Kroger stock higher.

Kroger Stock Cons

Net Total Debt: As a result of its $2.5 billion purchase of Harris Teeter, Kroger now has $11.2 billion in total debt, 45% higher than a year earlier. If it only paid $2.5 billion for Harris Teeter, what has driven the $3.5 billion increase in its debt levels? Share repurchases, of course. In the first two quarters of the year, the company repurchased  27.4 million shares of Kroger stock at a cost of $1.2 billion. Essentially, it borrowed close to 85% of the funds used to make those buybacks. This could come back to haunt it both in terms of debt levels and the fact it might well have overpaid for these shares.

Unionized Work Force: Kroger announced in September that it plans to add 20,000 permanent jobs to its work force to go with the 40,000 it has added over the past six years. While this is great news for the economy, it might not be a bed of roses for shareholders. That’s because a majority of its 375,000 full- and part-time employees are covered by 300 collective bargaining agreements providing healthcare and pension benefits that some of its competitors aren’t responsible for. While negotiations appear to be going well, the added pressures of a unionized workforce is always a concern.

Valuation: Blumenthal believes Kroger stock is undervalued compared to its peers. I think there’s no doubt she’s right. However, up 35% year-to-date through Oct. 7, it seems to me that buying aggressively at this point would be overplaying your hand — especially when you consider that the markets appear ready to implode. In relative terms, Kroger stock might appear cheap, but in terms of the macro view, I’m not sure that will matter.

Bottom Line

If you must buy, I’d consider something like the PowerShares Dynamic Retail Portfolio (PMR) which gives you some diversification just in case Kroger stock has temporarily run its course. As the No. 1 holding with a weighting of 5.41%, you’re getting Kroger and then some.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

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