The Federal Reserve has adopted an exceptionally aggressive policy this year to restore inflation to its long-term target of 2%. To this end, it has raised interest rates at a record pace this year. Plus, it intends to raise them even further next year. Higher interest rates exert a drag on the economy, as they reduce the total amount of investments, and hence they have increased the risk of an upcoming recession.
Grocery stocks are not immune to recessions, but they have proved fairly resilient, as consumers have to visit grocery stores even under the most adverse economic conditions. In this article, we will discuss the prospects of three grocery stocks. These companies have proved fairly resilient to recessions and offer reliable dividends.
Founded in 1883, Kroger (NYSE:KR) is one of the largest retailers in the U.S. The company has nearly 2,800 retail stores under two dozen banners, along with fuel centers, pharmacies and jewelry stores in 35 states.
Thanks to its immense network of stores, Kroger enjoys significant economies of scale. However, competition has heated more than ever in the retail sector in recent years. As a result, Kroger operates with razor-thin margins. Thus, it lacks a meaningful business moat.
On the other hand, Kroger has proved resilient during recessions. In the Great Recession, while most companies saw their earnings collapse, Kroger incurred a benign 8% decrease in its earnings per share, from 95 cents in 2008 to 87 cents in 2009. During the coronavirus pandemic, Kroger performed even better. Thanks to the lockdowns imposed in response to the pandemic, at-home consumption greatly increased. Thus, Kroger grew its EPS 58%, from $2.19 in 2019 to an all-time high of $3.47 in 2020.
Even better, the company has maintained its positive momentum, with 6% EPS growth in 2021 and 11% expected growth this year. Kroger has benefited from its “Restock Kroger” project, which has improved the efficiency of the company and enhanced its operating margins. The bottom line has also been assisted by meaningful share repurchases. As the stock of Kroger has traded at low price-to-earnings (P/E) ratios in recent years, the share repurchases have greatly enhanced shareholder value.
In mid-October, Kroger announced that it agreed to acquire Albertsons (NYSE:ACI) for $24.6 billion. As the value of the deal is 75% of the market capitalization of Kroger, it is obvious that this acquisition is major for the future prospects of the company. Regulatory authorities are concerned that this deal may result in higher prices for consumers. As a result, no one can be completely sure that the deal will materialize. Nevertheless, if the deal is approved by regulators, it will probably prove a significant growth driver for Kroger.
Kroger has a decent dividend growth record. It has raised its dividend for 17 consecutive quarters and has grown its dividend by 14% per year on average over the last five years. The stock is currently offering a 2.3% dividend, which is a nearly 10-year high for the stock. Given its healthy payout ratio of only 25%, Kroger is likely to continue raising its dividend for many more years, though it will probably have to reduce its dividend growth rate if it spends $24.6 billion on the aforementioned acquisition.
Founded in 1902, Target (NYSE:TGT) has approximately 1,850 big box stores, which offer general merchandise and food and serve as distribution points for the company’s burgeoning e-commerce business. After a failed attempt to expand into Canada, Target has operations solely in the U.S. market.
Due to intense competition and the excessive losses it incurred during its expansion attempt, Target failed to grow its EOS meaningfully between 2012 and 2017. However, thanks to its turnaround efforts, Target has returned to its long-term growth trajectory in recent years. Notably, the retailer grew its EPS by an impressive 47% in 2020, partly thanks to the tailwind from the pandemic, and by another 44% last year. During the last decade, the company has grown its EPS by 13% per year on average. It also proved fairly resilient in the Great Recession, when EPS dipped only 14%.
Unfortunately, Target has been severely hurt by the surge of inflation to a 40-year high this year. Due to excessive inflation, the company has incurred a sharp contraction in its operating margins. In addition, the surge of inflation has made consumers more conservative in their discretionary spending. As a result, Target has experienced soft demand. Thus, its inventories have greatly increased. Due to these headwinds, the company is poised to incur a nearly 60% plunge in EPS this year. This helps explain the 42% slump of the stock off its peak in April.
On the bright side, thanks to aggressive interest rate hikes, inflation is likely to subside in the upcoming years. As a result, Target is likely to enhance its margins from its current razor-thin levels. The company also has some significant growth drivers in place, namely its small-format stores and share repurchases.
Target has raised its dividend for 54 consecutive years and therefore belongs to the Dividend Kings. The company raised its dividend by 20% this year, and its payout ratio has jumped from 23% in 2021 to 79% now. However, thanks to the expected recovery of its business, Target will likely be able to keep raising its dividend for many more years. Therefore, the 2.8% yield of the stock should be considered safe. Additionally, the 20% dividend raise announced in June is a testament to the confidence of management in the company’s recovery.
SpartanNash (NASDAQ:SPTN) is a value-added wholesale grocery distributor and retailer. It supplies 2,100 independent grocery retail locations in the U.S. and also owns itself 147 supermarkets in nine states. SpartanNash operates under retail banners such as Dan’s Supermarket, D&W Fresh Market, Econofoods, Family Fare, Forest Hill Foods and No Frills. The company is also a distributor of grocery products to U.S. military commissaries.
SpartanNash has been much less affected than Target by the surge of inflation this year. The retailer has managed to partly offset its increased supply-chain costs with improved efficiency and cost reductions. With only one quarter left, the company expects to grow its sales from $8.9 billion in 2021 to between $9.5 billion and $9.7 billion this year. This implies 8% growth at the mid-point. It also expects to grow its EPS from $1.70 in 2021 to $2.27-$2.37 this year, implying 36% growth at the mid-point.
On the other hand, SpartanNash has a remarkably volatile performance record. The company has grown its EPS by only 2.2% per year on average over the last decade, with pronounced volatility. Given that the retailer is on track to post nearly all-time high EPS this year, investors should be aware of its choppy performance record.
In the Great Recession, SpartanNash incurred a 25% decrease in its earnings per share. Therefore, it performed worse than Kroger and Target but still proved fairly resistant to recessions. The company has raised its dividend for 12 consecutive years and is currently offering a 2.7% dividend yield, with a payout ratio of 36%. Thanks to the healthy payout ratio of SpartanNash and its manageable amount of debt, its dividend should be considered safe. On the other hand, the company has grown its dividend by only 5% per year on average over the last five years. Given the volatile performance of the retailer, it is prudent not to expect greater dividend raises going forward.
On the date of publication, Bob Ciura did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.