Last year I had something in common with the great Warren Buffett of Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B).
What exactly was that? Kroger (NYSE:KR). I bought 100 shares last year, for $2,549. Buffett bought over $500 million worth.
The difference is that I sold mine in January for $2,870, after pocketing $46 in dividends. Buffett just acquired his.
I think we both saw the same things in Kroger. It’s a grossly undervalued company selling at one-fifth its sales volume. It has 10% of the U.S. grocery market, second only to Walmart (NYSE:WMT).
So why did I get out when the Oracle of Omaha was getting in?
Kroger Fiefdoms
Unless you’ve been reading my Kroger coverage regularly you may not know that Kroger isn’t just one company. It contains multitudes. Oregon has Fred Meyer. In California it’s Ralphs and in Kansas it’s Dillons. Colorado has King Soopers. In North Carolina it’s Harris Teeter.
Each of these companies is run separately. This confuses even reporters. Its decision to leave North Carolina to Harris Teeter was initially headlined by the local press as “Kroger leaves North Carolina.”
Kroger is beginning to recognize that this is silly. It began an ad campaign in all these stores late last year, under the slogan “fresh for everyone.” The implication is that, over time, the stores will become one chain, likely under the Kroger name.
The problem is that this strategy, too, is now out-of-date. Successful grocers, like Texas’ H-E-B, have different formats for different markets. Wealthy shoppers might go to a Central Market store, Hispanic shoppers might prefer a Mi Tienda store.
But after Kroger bought Mariano’s in Chicago in 2017, it turned the stores into Kroger locations. It destroyed that company’s unique identity for a bland, middle-class sameness.
Not That Underpriced
Kroger is “underpriced” because Kroger is badly run. The company is next due to report results March 5. Earnings of 55 cents per share are expected on revenue of $28.8 billion. That’s only 2% more revenue than for the same quarter last year. The dividend of 16 cents yields 2.2%. The stock is up $2.50 this month, largely on Buffett’s purchase.
During the fourth quarter Kroger traded as low as $24 per share. Buffett is probably getting a price-to-earnings ratio below 15 and his yield is closer to 2.5%. But you’re not likely to do as well unless Kroger makes significant changes.
Those changes were foreshadowed by the company now known as Macy’s (NYSE:M). The then-bankrupt New York chain was bought by Cincinnati-based Federated Department Stores in 1994. In 2005, Federated’s regional stores all took the Macy’s name, with Bloomingdale’s retained as an upscale brand.
This worked, so long as the middle class kept going to department stores. Once such stores were abandoned, Macy’s had nowhere to go but down. The market capitalization of Macy’s is now $5 billion, on trailing-year sales of $25 billion. You may notice that’s the same price-to-sales ratio as Kroger.
The Bottom Line on Kroger Stock
Kroger stock can be a winning investment, but not until it undergoes fundamental change.
It needs to rid itself of regional fiefdoms and differentiate based on demographics. It needs to turn store brands like Murray’s Cheese into symbols of quality, as Target (NYSE:TGT) has done.
That’s not the kind of work Buffett does. It’s the kind of work hedge funds like Elliott Management are known for. If Buffett could recruit such a firm to join him, or sold his Kroger stake to such a firm, I’d be a buyer.
But I’m not buying this Kroger.
Dana Blankenhorn has been a financial and technology journalist since 1978. He is the author of the environmental thriller Bridget O’Flynn and the Bear, available at the Amazon Kindle store. Follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this story.
