Kroger an Underappreciated Value Stock

Some stocks keep getting better and better over time. Case in point is Kroger (NYSE: KR). The latest round of financial numbers indicates that Kroger became an even better value in the second quarter of 2015.

The numbers show us that the recent stock split has made Kroger one of the most under-appreciated and undervalued stocks around. It is also one of the best bargains in the market today.

A few of the highlights from Kroger’s latest financials that investors should pay attention to include:

• Kroger is tremendously undervalued. It had a market cap of $35.81 billion and an enterprise value of $46.25 billion on September 15, 2015.

• Kroger generates an incredible amount of revenue. It reported a TTM revenue of $108.78 billion on July 31, 2015. That makes Kroger the fourth largest U.S. retailer in terms of revenue; only Walmart Stores Inc. (NYSE: WMT), CVS Health (NYSE: CVS) and Costco Wholesale (NASDAQ: COST) have bigger revenues that Kroger.

 

• Kroger’s revenue growth is weak. It reported a year to year TTM revenue growth rate of .9% on July 31, 2015, up slightly from .27% on April 30, 2015, but very disappointing when you compare it to the 8.55% rate reported on January 31, 2015. This would seem to indicate that the only way Kroger can significantly grow its revenue is to make major acquisitions. Kroger might have also exhausted the limits of its markets. It might need to move into new regions, which is an expensive proposition.

 

• Kroger has a lot of cash. It made $4.168 billion in cash from operations and had $1.202 billion in cash from operations during the second quarter. Kroger also reported a net income of $1.932 billion and a free cash flow of $183 million for the second quarter.

• Kroger is fairly healthy financially. It reported $30.78 billion in assets and $24.9 billion in liabilities for the second quarter.

 

• Kroger is in a position to spend a lot of cash without putting itself at risk. It made $3.18 billion in capital expenditures in the second quarter.

 

• Kroger is still a great investment. It reported a dividend yield of 1.04%, a forward dividend yield of 1.12%, a payout ratio of 18.27% and a return on equity of 35.56% on July 31, 2015.

So What Does the Future Hold for Kroger?

My guess is that Kroger will concentrate on expanding its core business of food sales and adding cash-generating premium grocery services to its business. This will include adding more online services and premium brands to its stores.

Kroger is expanding its click and pull or click and collect grocery service, where employees prepare online orders for customer pickup to three more cities—Louisville, Kentucky; Indianapolis; and Portland, Oregon—where Kroger operates as Fred Meyer, The Cincinnati Business Courier reported. This is the first time that Kroger has offered the service outside of its Kroger, King Soopers (Denver area) or Harris Teeter branded markets.

This service could be an important revenue generator for Kroger because the company charges customers $4.95 for it. My guess is that it will soon be rolled out in lucrative West Coast markets like Washington State and California, where Fred Meyer operates Ralphs. Kroger currently offers the service in around 80 stores.

One reason for this service is to head off Amazon Inc.’s (NASDAQ: AMZN) entry into the grocery business with delivery services. Another is to appeal to more upscale customers in an age of salary stagnation and growing income inequality.

It goes without saying that Kroger’s click and collect service could be easily integrated with Google Inc.’s (NASDAQ: GOOGL) Google Express retail delivery experiment. Google Express allows customers to order items from a wide variety of stores, which are delivered by contracted couriers.

Kroger Takes Aim at Trader Joe’s with New Brand

Kroger is also planning to launch a new upscale international food brand called Hemisfares later this month, CEO Randy McMullen announced in a recent conference call. The idea here appears to be to compete with Trader Joe’s and Whole Foods Market (NASDAQ: WFM), both of which have gained large followings among younger and higher-income shoppers by offering wide selections of foreign and ethnic foods.

McMullen and his team seem to have their finger on the pace of the American consumer. In particular they understand that the American palate is getting more sophisticated even though the average shopper is more price conscious than ever.

“We find customers are increasingly becoming foodies,” McMullen said. “And it’s really trying to figure out how do you find great products that will satisfy that foodie need experience they want in a way that is actually a very affordable price.”

“Some of this product, it’s the first time that anybody’s gone through the trouble of importing the product with some of the items into the U.S. that we have,” Schlotman said of Hemisfares. That makes the brand sound as if it’s aimed squarely at Trader Joe’s, which sells large amounts of imported gourmet items at low prices.

If Kroger can start undercutting Trader Joe’s and Whole Foods’ prices on such gourmet items, it could do serious damage to them, particularly since it offers many products and services those stores do not, including pharmacies, clinics and filling stations. Its loyalty cards in particular give it a powerful weapon in the war on Trader Joe’s as does it discounting expertise.

Kroger’s Secret Weapon in the Grocery Wars

The decision to launch Hemisfares was made in part on data analysis from what could be Kroger’s secret weapon in the grocery wars—an analysis firm called 84.51, The Cincinnati Business Courier reported. Kroger purchased the majority of the firm formerly called DunnhumbyUSA and changed its name to 84.51 in May.

Among other things, the acquisition gives Kroger access to proprietary solutions that analyze customer habits and create marketing and other solutions. That will make it easier for Kroger to analyze all the information it collects about its customers from registers, surveys and other sources and create targeted marketing efforts. Examples of such targeted marketing could include new brands and coupons directed at specific customers.

This gives Kroger data analysis abilities that rival those of Walmart. It also marks an escalation of the grocery wars that could spell big trouble for smaller chains with fewer resources, including Whole Foods, Sprouts Farmers Market (NASDAQ: SFM), Supervalu (NYSE: SVU) and Safeway/Albertsons. Other potential casualties could include dollar stores, Walmart, Target (NYSE: TGT) and Costco Wholesale (NASDAQ: COST).

What Will Kroger Acquire Next?

Okay, this brings us to the $1 billion question: What will Kroger acquire next? My take on it is more technology companies, particularly those in the delivery sphere. One potential target would definitely be PeaPod; another would be Instacart.

Instacart, which is supposedly worth two billion, would be a good fit for Kroger. If Kroger could integrate it with Click and Collect, it could have a real winner. Instacart has the technological solution, an app, but it does not have the infrastructure for widespread grocery delivery that Kroger does. One strong possibility would be that Kroger will make the kind of deal with Instacart it made with Dunnhumby and buy out part of the company to get its hands on technological solutions and a powerful engineering team.

Beyond that, I imagine Kroger will concentrate on buying smaller regional grocers and possibly stores from other chains. It might take over some stores that Safeway/Albertsons are spinning off for example. My guess it will not make a major grocery acquisition unless a very well run supermarket chain that would be a good fit with its operations comes up for sale. Possibilities there might include Meijer or Sprouts.

The financial numbers reveal that Kroger is still a great investment, although it will have a difficult time growing. No matter what else happens, Kroger’s stock is still a great value.

Disclosure: Your friendly neighborhood blogger owns shares of Kroger and plans to keep them for a long, long time.