Kroger (NYSE:KR) stock is in rare company. Among stocks with a market capitalization over $10 billion, only about 12% have risen so far in 2020. Fewer than 5% have outperformed Kroger stock, which has gained a healthy 5.6%.
It’s tempting to chalk up the gains to the novel coronavirus pandemic. Consumers have stocked up on essentials ahead of shelter-in-place orders. and that trend has given a big short-term boost to Kroger sales.
But there’s been more to the 2020 gains than just a short-term boost. And there’s more to the long-term case, as well.
This is one of the country’s best companies. Even after the gains, KR stock still looks cheap. In fact, it looks too cheap. And that’s just one of the reasons why Kroger stock should keep rallying.
Kroger Gets a Boost
On Wednesday, Kroger provided a business update for investors. The company noted “strong sales” in February, the first month of its fiscal year 2020. But March was far more impressive.
According to the release, same-store sales excluding fuel rose a staggering 30%. As a result, Kroger expects its adjusted earnings per share (EPS) growth in the first quarter to be better than its original full-year guidance. That guidance suggested a 5-10% year-over-year increase in FY20.
Investors might see even that guidance as conservative. It could be, but it’s worth considering two important factors.
First, Kroger’s costs are going up as well. The company is providing a “hero bonus” of $2 per hour to its hourly frontline employees. Increased sanitation and installation of safety measures like plexiglass partitions will also increase expenses.
Certainly, Kroger’s first quarter earnings will look solid. But it’s unlikely that earnings will grow at the same pace as sales, given higher costs.
Secondly, a short-term boost alone doesn’t make KR stock a buy. That’s true for any stock. Indeed, I’ve made that argument in expressing caution toward “pandemic plays” like Lakeland Industries (NASDAQ:LAKE) and Alpha Pro Tech (NYSEAMERICAN:APT) that have seen huge gains.
The burst in demand will put some extra cash on Kroger’s balance sheet. That’s helpful, but doesn’t make Kroger stock a buy. However, the March figures do show that one key risk might not be what investors believed.
Competition for Kroger
KR stock hasn’t exactly lit the world on fire in recent years. The stock entered 2020 at the same levels at which it traded in late 2014.
One key reason for this has been competition. Walmart (NYSE:WMT) has improved its execution and spent heavily on omnichannel retail and grocery delivery and pickup. Meanwhile, Target (NYSE:TGT) has also turned itself around.
Additionally, low-cost German operators Aldi and Lidl have expanded across the country. And while competition in the industry always is intense, Kroger has more and better competitors out there now.
That’s put a lid on the multiple assigned to KR stock. Free cash flow actually has increased over the last six years, as well as adjusted EBITDA. Yet, investors have paid less for those earnings — due at least in part to competitive fears.
What recent results show, however, is that Kroger is holding its own. It’s not just the 30% increase in March same-store sales, either. Same-store sales excluding fuel (fuel revenues are significantly impacted by gasoline prices) rose a solid 2% in fiscal 2019.
Overall, Kroger is competing hard in a tough space. And while it’s not exactly dominating competitors, it’s at least driving growth. That growth, however, doesn’t seem reflected in the KR stock price.
KR Stock Looks Cheap
In updating on its sales trends for February and March, Kroger reaffirmed full-year fiscal 2020 adjusted earnings per share guidance of $2.30-$2.40.
At the midpoint of that range, EPS would increase about 7.5%. But, Kroger stock trades at less than 14 times the midpoint of that guidance.
That multiple doesn’t seem to reflect the growth profile of the business — even excluding the short-term bounce. As recent results show, KR is a defensive stock, whose earnings can and will hold up even in a recession. Profits are still growing, but the valuation assigned KR stock treats its future growth as close to zero.
That’s not what is happening now. It’s not what happened in a particularly strong fourth quarter, either, in which adjusted EPS increased 19% year-over-year.
Even the year-to-date rally doesn’t seem to incorporate that growth. Kroger is still one of the cheapest large-cap stocks out there. Its business clearly is built for pretty much any environment, and it’s matched the efforts of larger rivals in delivery and pickup.
That said, it’s that combination that underpins the long-term case for KR stock. That case looks solid, and will stay that way even once this crisis passes.
Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities.