It’s not a good time to be a grocer. Then again, the salad days (so to speak) are long gone for grocery stores likes the Kroger Co. (NYSE:KR).
Like all businesses that offer consumer staples such as groceries, there’s the land-grab phase, the establishing-your-brand phase, the growth phase and then, the business becomes a commodity. That’s where things fall apart. That’s how things have been in the grocery business for quite some time, and we’ve seen it reflected in KR stock.
A Look at Kroger
Grocery stores are really just distribution centers, and KR stock has been behaving like a business that is just a distribution center. Stores all carry the same products. They all see opportunity to serve a given community so they try and establish a presence to generate revenue in that community. However, since they all sell the same thing, the differentiation comes down to things like prices, customer service, convenience, location and little things here and there to try to make a store stand out.
Those little things can make a temporary difference. I’m reminded of two Indian restaurants on Manhattan’s Lower East side around the year 2000. They literally each occupied one side of a duplex storefront. One day, one store put up Christmas lights in the store window to attract customers. The next day, the other store did the same thing. Then one store put up pinwheels. The other one did the same. This apparently went on for years and years, to the point where both restaurants’ storefronts were jammed with every conceivable piece of eye candy. And each proprietor stood on the steps imploring passers-by to try his food. It was hilarious, but also instructive in the grocery wars in which KR stock participates.
Thus, KR stock has fallen, along with peers, because price wars are really the primary tool of competition and little things could be piled on top of that. This all first took the form of “club cards” that got shoppers discounts, which all the other stores copied. Then it was private label products to undercut the brands that were still carried on the shelves. Then it was offering organic products.
So the problem with the grocers, and with Kroger, is that there’s all this competition and the market is heavily fragmented. Kroger owns about 10% of the market, and besides all the other brand names, a whopping 30% of the market is owned by a bunch of small names.
We’re finally seeing this structure impact KR stock, as comparable store sales finally slumped after doing well for almost 14 years. Given that it has such a comparatively high market share, that’s why it took so long for competition to impact in this manner. It also has a form of “moat” in its 3,000 store footprint across 35 states. So what Kroger must do now is focus more on its online operation. It needs to squeeze as much non-perishable purchases out of the online business as it can.
The Bottom Line for KR Stock
Analysts are pretty bearish on KR stock and its earnings prospects, seeing a 2.5% annual contraction in earnings over the next five years. So, with TTM net income of $1.55 billion, and a market cap of $18.3 billion, KR stock trades at a P/E ratio of 12. However, that is on EPS being flat to down.
TTM free cash flow is still reasonable at $1.3 billion, but KR is loaded with $11 billion in debt and only $300 million cash on hand. There’s no danger here, in that debt service is $522 million and that is easily covered.
The issue is that all this makes KR stock look very expensive, without much to make me feel optimistic.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
