Continuing food deflation hit Kroger Co (NYSE:KR) right in the mouth in its fiscal first quarter. But it was a cut to earnings guidance that really nailed Kroger on Thursday, sending KR stock down by 18% in early trading.
The reported numbers were not that bad. The company earned $303 million (33 cents per share) on revenues of $36.285 billion. The top line was ahead of estimates, while the bottom line in-line with them.
No, what had investors exiting KR stock was the company’s warning that full-year results would come in below previous guidance. Kroger had estimated earnings of $2.21-$2.25 per share. Its new estimate is just $2-$2.05 per share.
Kroger is the nation’s third-largest retailer, well behind Wal-Mart Stores Inc (NYSE:WMT) but very close to Costco Wholesale Corporation (NASDAQ:COST) in size, and analysts were quick to point the finger at both those competitors — especially Walmart — for Kroger’s troubles.
For the record, WMT shares are up 11% over the past year while KR is down 30%.
People Smarter Than Economists
While most economists — including those at the Federal Reserve Board, which raised interest rates June 14 — seem to feel the economy has clear sailing ahead, consumers are battening down the hatches, searching for value. This is especially true for upper middle-income people, who are flocking to Costco for its super-low margins and thus buying less at mainline grocery stores like Kroger.
But what economists, and even stock analysts, don’t understand is that Kroger is more than just a single grocery store chain.
As I noted in my pre-earnings story, Kroger has dozens of store brands, ranging from department stores like Fred Meyer to convenience stores. KR also produces many of its own packaged goods. This means it can get bigger margins in the stores, but it also exposes the company to the deflationary pressures now hitting the food business.
Kroger’s operating cash flow for this recent “bad” quarter came to $2.3 billion, up from $2.1 billion a year ago. And this quarter, it cut the current portion of its long-term debt obligation substantially, from $2.676 billion to $1.854 billion.
If hatches need to be battened down, Kroger is very capable of battening them.
Analysts know Kroger is not the sick man of this group. The entire grocery store universe was hurt by its lowered guidance. Whole Foods Market, Inc. (NASDAQ:WFM) fell almost 4% in early trade on June 15, Sprouts Farmers Market Inc (NASDAQ:SFM) was down 6% and even Walmart fell nearly 2%.
Moves Overdone Both Ways
Still, headlines preferred to focus on the 22% drop in earnings, ignoring the deflation story. Investors sold the entire grocery group.
The July 15 “debacle” cut the price-to-earnings ratio on KR stock to less than 13 — half that of the average stock in the S&P 500. Its market cap sank to $24 billion, compared with 2016 sales of $115 billion. That’s half what Walmart and Costco are selling for, and even lower than the price to sales ratio for Macy’s Inc (NYSE:M).
At its June 15 price, Kroger is down 40% from the peak of $42.46 per share it enjoyed near the end of 2015, after a 2-for-1 stock split had investors thinking the company could do no wrong. Now they think it can do nothing right.
Neither view is true.
Kroger is a stable company with a growing top line and a talent for expanding at low cost, as with Murray’s Cheese and its most recent pick-up, the 11 Marsh stores in Indiana which it bought at a bankruptcy sale.
Bottom Line on KR Stock
If you see, as I do, that deflation and stupid Washington policies have consumers pulling in their horns, then Kroger may remain a good place to wait out the storm.
Kroger is continuing to repurchase shares, and can easily afford the 12-cent per share dividend you’ll get to stay in KR stock. That’s a yield of 1.8% — close to the rate being paid on a 10-year bond.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at firstname.lastname@example.org or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this article.