Kroger Co (NYSE:KR) stock is one of the worst-performing stocks of 2017, down 39.79% year-to-date. Most of this decline occurred since June. KR stock fell 19% on June 15 after warning of lower profits this year. The very next day, more bad news struck retail stocks. Amazon.com, Inc. (NASDAQ:AMZN) announced its decision to purchase Whole Foods Market, Inc. (NASDAQ:WFM) for $13.7 billion.
Emotions such as fear and greed drive markets, but investors sometimes overreact. As experience will show you, not all your hopes and fears end up being realized.
Could the market be overreacting to news of Amazon’s acquisition? Could Kroger stock rebound in the coming weeks as fears subside?
Maybe. Although Amazon is a formidable competitor, the company hasn’t succeeded in everything.
Some see these worries as overdone. SunTrust analysts note that there isn’t much overlap; only 10% of Kroger’s stores can be found within 3 miles of a Whole Foods market.
Let’s look at the strengths and weaknesses of KR stock.
KR Stock Pros
Valuation: With the S&P 500 trading at a whopping 25 times earnings, it’s getting really difficult to find cheap stocks. Kroger stock currently trades at 12.28 times earnings.
While such a stock wouldn’t have been seen as “cheap” in the past, it is now. Kroger’s price/earnings multiple is the 37th lowest in the S&P 500.
KR stock currently boasts the fourth-lowest price to sales ratio in the index, and two of the stocks trading at lower multiples currently operate at a loss.
Size: Bigger firms benefit from economies of scale, including greater bargaining power with suppliers. Kroger’s sales over the past 12 months exceed $118 billion. This makes Kroger the world’s third-largest retailer by revenue; only Wal-Mart Stores Inc (NYSE:WMT) and Costco sell more than KR.
Kroger ranks #40 on the Fortune Global 500. The company operates supermarkets under a variety of brands, including Kroger, Harris Teeter, Ralphs, Smith’s, and City Market. Kroger also operates gas stations and is the third-largest jeweler in the United States.
Dividend Growth Stock: Kroger’s past dividend growth is impressive. In 2012, KR stock paid 25 cents per share in dividends. Over the following years, Kroger nearly doubled this, paying out 45 cents per share last year, an impressive 80% growth in just four years.
Currently, KR stock yields 2.46%, putting it in the upper half of the S&P 500 in terms of dividends. With a relatively low payout ratio (28.7%), Kroger could continue growing its dividend for years to come.
KR Stock Cons
Amazon: “Past experience shows us that having Amazon enter your industry is generally not a good thing,” I wrote in an article on Bank of America Corp (NYSE:BAC) stock in July. Amazon’s efficiency, scale and expertise with data make it a tough competitor, and Amazon does not fear low margins.
With its purchase of Whole Foods, Amazon seems intent on getting into the grocery business. And in August, Amazon cut prices at Whole Foods stores.
“Amazon will materially gut the three things that grocery stores thought would keep them competitive: their private label brands, their shelves of organic foods and their loyalty programs,” warned Karen Webster in an article published shortly thereafter.
Aldi and Lidl Expansion: If this weren’t bad enough, Kroger will also have to deal with more competition from German discount retailers such as Aldi and Lidl. Aldi, which currently operates 1,600 stores in the United States, plans to add 400 more by the end of 2018 and will spend $1.6 billion to remodel 1,300 of its existing stores. By the end of 2022, Aldi hopes to have 2,500 stores in the US.
Debt: Kroger holds $819 million in cash but owes $14 billion in debt. KR stock’s market capitalization is $18.11 billion; its enterprise value, at $31.44 billion, is a bit higher.
In my article on Rite Aid Corporation (NYSE: RAD), I stated that analysts should look at enterprise value rather than market capitalization. Enterprise value gives us a clearer picture since this takes debt into account.
And when we look at Kroger’s valuation using enterprise value instead of market capitalization, the stock no longer seems so cheap. Kroger’s price to free cash flow multiple of 13.47 is low; its enterprise value to free cash flow multiple, at 22.62, not so much.
The Verdict on KR Stock
It looks like supermarkets are in for a tough time. Increased competition is putting pressure on food prices. At the same time, a tight labor market means rising labor costs for Kroger. Kroger employs 443,000 workers, making it one of the largest employers in the United States.
Is KR stock undervalued, or is the market correctly pricing in all these difficulties? Time will tell.
However, people do need to eat, and food prices could always go up tomorrow. I think there is a good case for investing in food and agriculture.
I would rather invest in a commodity such as food than in a commodity such as oil or gas. People will most likely still need to eat in 2067; I can’t see this changing. But if Elon Musk ends up succeeding, 50 years from now, people won’t need to use oil and gas for fuel.
As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.