Amazon.com, Inc. (NASDAQ:AMZN) acquired Whole Foods Market, Inc. in mid-June for $13.7 billion. Kroger Co (NYSE:KR) is down 33% since. In fact, on October 2nd, KR stock hit 52-week and multi-year lows at $19.69. The shares stock can’t fall forever, can they?
In short, no. But the long answer is a bit more complicated. First, the Amazon-Whole Foods transformation will be fast, but it won’t be overnight. We know it will be fast — considering the grocer closed the deal in just over two months — incredible speed for two companies in completely different industries. It then took over its operations, began slashing prices and implementing its own concepts. The speed is remarkable.
A Fundamental Shift for Kroger
Obviously, Kroger’s market share won’t erode overnight. Whole Foods has been struggling through its own troubling operations. While profitable — which could help Amazon — its comparable-store sales continue to run in negative territory. AMZN will likely fix that by slashing prices, but will hurt gross margins and profits in doing so. It will also hurt Kroger.
It’s not just AMZN, though. The truth is, there is very little, if any food inflation in the U.S. right now. In fact, one could argue there is food deflation. Even before Amazon came along, the grocery stores had been struggling. When the deal was made public in mid June, KR stock was trading at $30, roughly flat over the previous 30 months.
But investors see AMZN’s entry as a long-term disruption. It may not hurt KR instantly, but it’s expected to grind down KR, Target Corporation (NYSE:TGT), Wal-Mart Stores Inc (NYSE:WMT) and others over time.
Thanks to Amazon’s burgeoning Prime network, fast delivery and dominance in e-commerce, many expect WFM’s bricks-and-mortar footprint to act as an extension for AMZN. Can KR counter this move?
Maybe, but sporting an almost-$18 billion market cap limits its ability to compete head-to-head with AMZN. Fresh cooked meals, same-day local grocery delivery and an emphasis on fresh food might help. But there’s no telling whether KR can hold off AMZN.
What Do the Numbers Look Like?
Analysts expect earnings of $1.97 per share this year, down from $2.12 in the prior year. In fiscal 2019 (next year), they’re looking for $1.98 in earnings. While sales are forecast to grow 5.6% this year, analysts expect that growth to slow to just 1.5% in fiscal 2019.
While management has beat revenue estimates in each of the past four quarters, they also struck out four times in a row too. KR stock now trades at just 12 times trailing earnings. That’s its lowest valuation since early 2014.Gone are the days of 10% earnings growth and healthy comp-store sales.
It’s not because of Amazon-Whole Foods, but the acquisition certainly won’t help. Amazon investors tend to give management a free pass on whatever it wants to do. Valuation doesn’t matter, while revenue and market share growth trump profits. It’s always been this way for AMZN.
Traditional grocers and competitors do not get this treatment. They’re tied to a valuation and investors expect profits, dividends and consistency. They realize the landscape is changing though, and that’s why KR stock trades at just 12 times earnings.
So What’s Next for KR Stock?
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The $20.50 to $21 level is very important for KR stock, as seen in our five-year weekly chart. However, with KR desperately clinging to $20, this level may have already failed. $20 is a line in the sand and I wouldn’t want to be long KR stock should it fail too. The 2.5% dividend is nice, but honestly, not enough to compensate for a 15% or more loss should KR stock erode further. This would take it to $17, where the second big level of support sits.
I don’t think Amazon will eat Kroger’s lunch overnight. Down about 50% from its highs may intrigue some investors even though the headlines look bad. With a limited-risk play, it’s hard to fault an investor for going long KR stock at $20 and bailing on a close below.
Near the bottom of the Great Recession, KR stock was sporting a P/E ratio of about 10.5. Using estimates of $1.97 in earnings this year and a Great Recession P/E low of 10.5, we still end up with a stock price of $20.68. While a flat stock price over the next 6 to 12 months doesn’t sound great, we can at least make a solid case of KR stock not being crushed. Perception is everything though, and investors could bail if they feel Amazon is gaining momentum.
Bottomline on KR Stock
My personal feeling is that we need grocery stores for many years to come. KR stock has a payout ratio of just 29% and pays a 2.5% dividend yield. It’s plenty profitable and has a low valuation. That’s worth something to some investors.
Even if KR stock doesn’t have massive upside from current levels, its downside should be limited. Just be careful of a break below $20.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
