Grocery stocks trade in a competitive, low-margin business. The average grocer sees a profit margin falling between 1% and 2%. Although that margin can rise as high as 6% for organic grocers, difficulties remain.
Despite the struggles to profit, grocery stocks have attracted a great deal of interest. The Amazon (NASDAQ:AMZN) purchase of Whole Foods spurred a great deal of interest in grocery stocks. Despite Amazon’s struggles with grocery delivery and its desire to build a second grocery chain, that interest has not abated.
This sector also poses challenges for many investors. Many prominent chains such as Trader Joe’s have never launched an IPO. Others, such as Publix offer stock that does not trade on public markets. Hence, relatively few grocers trade on the exchanges, and others, such as Walmart (NYSE:WMT), derive most profit from other retail operations.
Despite this challenge, investors can find grocery stocks with profit potential. These stocks to buy trade at reasonable price-to-earnings ratios while posting the profit increases needed to boost stock prices over time.
BJ’s Wholesale (BJ)
In the discussion of warehouse retail and grocery stocks, many often forget BJ’s Wholesale (NYSE:BJ). Instead, attention often falls on Costco (NASDAQ:COST), which has led the warehouse retail sector for many years. Even Sam’s Club, a division of Walmart, often receives more attention.
Since BJ’s operates warehouses primarily on the east coast, investors west of the Mississippi River often overlook the chain. Moreover, the company did not return to the public markets until its July 2018 IPO, giving investors further reason to ignore the warehouse retailer.
However, the company operates 216 warehouses in 16 states, and it carries more grocery stock-keeping units (SKUs) than either rival.
Moreover, BJ stock posts financials that would appeal more to buyers. The forward P/E ratio comes in at 15.5, lower than both Costco and Walmart. Wall Street also predicts a 10.5% increase in profits for the year. That almost matches Costco’s predicted growth rate. For next year, analysts forecast 11.6% profit growth versus only 7.4% for Costco.
BJ stock has challenges. High debt levels and negative stockholders’ equity will likely slow expansion plans. Also, at a market cap of only $3.5 billion, it will remain a distant third behind its main rivals for years to come. Further, the investment thesis may fall apart if profits fall short of forecasts. However, as long as BJ’s can keep growing its profits and improving its balance sheet, the future should brighten for BJ stock.
Kroger (NYSE:KR) has long held a position as the nation’s second-largest grocer. Due to Walmart’s more diverse retail portfolio, Kroger stands as the largest pure-play grocer trading on the market today. The Cincinnati-based company operates 2,764 grocery stores across the country.
Despite the massive footprint, investors sold off Kroger stock as fears of an Amazon takeover took hold. Most now believe investors overreacted to Amazon. Still, this threat has changed Kroger’s strategy. Kroger spent $3 billion last year remodeling stores and on the “Restock Kroger” digital initiative. They expect that spending to grow to $3.2 billion this year.
These changes have placed grocery stocks like Kroger in a position of transition. While unpopular, most analysts agree this spending has become necessary for Kroger to remain relevant. These sentiments became evident as Kroger missed earnings and revenue estimates in Q4. KR stock fell 9% on that news. Setbacks such as these have left KR trading at only 10.3 times forward earnings.
Still, analysts expect 4.7% profit growth this year and 7.7% the next. Moreover, the annual dividend of 56 cents per share has increased for the last ten years. This takes the yield to almost 2.3%. KR stock may struggle for now as it makes its transition. However, the low valuation along with the fruit that Restock Kroger will likely bear should bring profits to long-term investors.
Like in the general retail sector, Target (NYSE:TGT) also competes with Walmart and others in the grocery business. It has also followed the lead of Walmart, Kroger and other grocers in introducing grocery delivery and leveraging its omnichannel presence to compete with Amazon.
For now, TGT stock is riding high. In its most recent quarterly report, the company beat earnings and revenue estimates. It also saw its best traffic and sales numbers since 2005. Its Food & Beverage category has shared in these benefits.
Target has struggled with groceries in the past. However, an emphasis on fresh and organic foods has helped to turn this category around. Target generally has tried to build a more upscale image than its archrival Walmart. Hence, an emphasis on somewhat pricier and more exclusive foods serves this image well.
Despite its reputation, the multiple on TGT stock is anything but upscale. Target trades at a forward P/E ratio of 12.2, well under the 19.6 forward P/E of Walmart. TGT now trades around $76 per share, and this accounts for the 26% surge the stock has experienced since its Dec. 24 low. Analysts also forecast 8% growth this year and 6.9% the next for the Minneapolis-based retailer. Moreover, the annual dividend of $2.56 per share yields about 3.4%. It has also risen for 51 consecutive years.
Target’s multiple may still lag that of Walmart. But with the company showing robust growth numbers and its grocery segment gaining momentum, TGT should perform well compared to other grocery stocks.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.