Make no mistake about it. Bears are in control of the stock market now. If there were any questions about it before this past week, there aren’t any questions now. What’s the implication of this newfound market bearishness? It’s time to play defense. It’s time to pick up high-quality stocks with defensive attributes, like recession resiliency, low volatility fundamentals, a strong balance sheet, and a nice yield. What’s the one defensive stock I like more than others right now? Grocery store operator Kroger (NYSE:KR).
Broadly speaking, KR stock has all the attributes you’d look for in a high-quality defensive investment. The grocery industry has recession resiliency since everyone needs to eat, regardless of how the economy is doing. This is especially true for Kroger, which largely operates low-price grocery stores. Also, Kroger stock trades at just 12.1x forward earnings and has a 2%+ dividend yield. The balance sheet has a lot of debt, but it’s shored up by a 5% free cash flow yield.
All together, there’s a lot to like about the high-quality defensive attributes of KR stock.
Kroger Is A High-Quality, Low-Volatility Business
At it’s core, the reason to own Kroger stock comes down to the company’s rock-solid operational fundamentals.
Specifically, Kroger is America’s largest grocery chain operator. The grocery industry is one of the more-stable industries in the world. Regardless of economic conditions, consumers globally need to eat. When times get tough, consumers tend to shift towards eating at home versus eating out. They also tend to shop at more-affordable grocery stores like the ones Kroger operates. So, regardless of which way the economic winds shift, Kroger’s business should be very stable.
Just look at what happened during earlier downturns. In 2008-09, Kroger’s supermarket sales growth slowed from 6.1% in 2008 to 2.9% in 2009. Still, that nearly 3% supermarket sales growth in 2009 — during one of the worst U.S. recessions ever — is still very healthy. That helped limit the downside on KR stock dropped to just about 30% off its pre-downtun highs, while the S&P 500 index shed nearly 60% in the same period.
This relative recession resilience should remain in place for the foreseeable future. Some bears want to knock the Kroger business today, citing increased competition from the likes of Amazon (NASDAQ:AMZN), Walmart (NYSE:WMT), and Target (NYSE:TGT). But, all of those competitors have been around for awhile and Kroger has reported mostly positive comparable sales growth.
Also, there is a new report circulating from UBS that Amazon continues to struggle with its big grocery push. Despite a roster of huge initiatives from Amazon, including the acquisition of Whole Foods, the number of Amazon Prime members who do shop for groceries through Amazon at least once a month actually dropped year-over-year in 2018.
This is yet another reason to believe that Kroger’s operational fundamentals in the grocery industry are both high quality and low volatility. Those characteristics added to the allure of KR stock as defensive play amid market turbulence and uncertainty.
Kroger Stock Valuation Has Defensive Attributes
Beyond stable operational fundamentals, Kroger’s valuation and financials are also defensive in nature.
The stock trades at just north of 12x forward earnings. That is below the market-average multiple of 15x forward earnings, which is also the level where Kroger stock has historically traded over the past five years. KR stock is also trading at a discount to its five-year average price-to-sales multiple, price to cash flow multiple, and EV/EBITDA multiple.
Beyond the valuation, Kroger stock features a healthy 2% dividend yield, which is supported by a really low 11% payout ratio. The current yield is above the five-year average of 1.5%, and the payout ratio is below the five year average of 20%. Meaning: KR stock has an above-average yield that is hardly overextended.
One non-defensive consideration is the $15 billion of debt on Kroger’s balance sheet. That’s more debt than this company has ever carried. But, the debt-to-EBITDA ratio is just a hair over 2, so the company certainly isn’t over-levered. Plus, the free cash flow yield is in excess of 5%, so there’s more than enough cash flow to service the debt.
Bottom Line on KR Stock
With bears in control of the market, it’s time to play defense, and one of the best stocks to play defense with in this environment is Kroger. Not only is the investment supported by high-quality and low-volatility operational fundamentals, but KR stock is also cheap with a healthy yield and a lot cash flow.
As such, Kroger is a high-quality defensive name that should perform reasonably well amid volatile markets.
As of this writing, Luke Lango was long KR, AMZN, and TGT.
