Berkshire Hathaway (NYSE: BRK.B) has made a surprising investment in America’s standalone grocer; Kroger (NYSE: KR).
Warren Buffett’s company; Berkshire Hathaway (NYSE: BRK.A), bought 19 million shares of Kroger for $549 million in 4th Quarter 2019, Investor’s Business Daily reports. Surprisingly, Berkshire reduced its stake in Apple (NASDAQ: AAPL) by 1%, or 3.7 million shares.
Buffett is showing his contrarian views here by rejecting the conventional wisdom that Apple is the future and Kroger is the past. Additionally, Buffett is selling an expensive stock for cash. Mr. Market was paying $324.95 a share for Apple on 14 February 2020. I think Buffett thinks Mr. overprices Apple, and I agree.
Why is Warren Buffett Buying Kroger stock?
I guess Buffett’s main rationale for buying Kroger is that the grocery giant is one of the few cheap stocks around these days.
Mr. Market priced Kroger at $28.30 a share on 14 February 2020. Yet, Kroger reported $27.974 billion in quarterly revenues and total assets of $45.939 billion on 31 October 2019.
Given those numbers, I think Kroger is a value investment Mr. Market underprices. I think Berkshire’s purchases indicate Buffett agrees.
Is Kroger a Value Investment?
I consider Kroger a value investment because of its vast footprint and massive retail infrastructure.
For example, Kroger (NYSE: KR) operates 2,761 supermarkets in 35 states. Other Kroger assets include 44 distribution centers, 222 in-store health clinics, 319 jewelry stores, 2,270 pharmacies, 1,537 supermarket fuel centers, and 36 food production plants.*
Kroger also owns a stable of historic supermarket brands that includes Ralph’s, Fred Meyer, Smith’s King Soopers’ Fry’s, Copps, Baker’s, Mariano’s, Harris Teeter, City Market, Pick n’ Save, QFC, and Metro Market.
Beyond that, Kroger owns the Vitacost discount vitamin and supplements online retailer and the Home Chef meal delivery service. In addition, Kroger Murray’s Cheese, a gourmet cheese company.
Kroger is a major player in the organic and natural foods markets. Kroger claims to have sold $17.6 billion in natural and organic food in 2018. In detail, Kroger claims to sell 9,000 organic items. Plus, Kroger claims its Simple Truth natural and organic brands reached $2.3 billion in sales in 2018.
Consequently, Kroger has a lot of value because of its brands and infrastructure.
Is Buffett betting for or against Grocery Delivery at Kroger?
Strangely, Buffett is betting for grocery delivery’s success and against grocery delivery’s success at Kroger.
First, Buffett is betting Kroger’s brick and mortar stores will keep vast amounts of value. I guess Buffett thinks most people will keep buying groceries from brick and mortar stores for many years.
Accordingly, Gallup estimates that 81% said they did not buy groceries online in August 2019. However, Gallup found 19% of Americans say they order groceries online.
Buffett is hedging his bet because Kroger is investing heavily in online grocery ordering and delivery. For example, 1,600 Kroger supermarkets pickup of groceries ordered online in February 2018, The Kroger Fact Book* claims.
Buffett Hedges his Bet on Online Grocery Delivery
Plus, Kroger has a close relationship with Instacart. A Kroger press release claims, Instacart grocery delivery is available from 50% of Kroger’s stores, or over 1,600 supermarkets.
Beyond Instacart Kroger and Britain’s Ocado Group PLC (LON: OCDO) plan to build six robotic customer fulfillment centers (CFC) in the United States to support same-day grocery deliver.
Ocado’s robots will pull and pack grocery delivery orders at Kroger’s new CFCs. They will locate the latest Kroger/Ocado CFC in Pleasant Prairie, Wisconsin, just north of Chicago, Supermarket News reports. Thus, Kroger and Ocado can serve customers in Chicagoland. Chicago is America’s third largest city with 2.706 million people in 2020.
Thus, Buffett can make money if online grocery delivery fails or succeeds by owning Kroger. To explain, people will still need food and Kroger can supply it through either brick and mortar stores or delivery.
Is Kroger the Future of Grocery and Meal Delivery?
In addition, Kroger’s 2,761 supermarkets can serve as neighborhood delivery hubs for delivery services such as Instacart. Notably, many supermarkets have delis, pizzerias, cafes, kitchens, and other facilities that can provide both hot food and groceries.
Thus, Kroger could theoretically make money from Grubhub (NYSE: GRUB), besides Instacart. Grubhub deliveries, hot meals and prepared food while Instacart delivers groceries.
I think the long-term trend in grocery delivery will be services that deliver both hot food and groceries. For example, Grubhub or Instacart could deliver your milk and laundry detergent and your dinner.
Buying Grubhub, which is reportedly for sale, could be a smart move for either Kroger or Berkshire Hathaway. I think Grubhub is an acquisition target because it is cheap. Mr. Market gave Grubhub a market capitalization of $4.608 billion and a share price of $50.39 on 14 February 2020.
Is Kroger Making Money?
The Kroger Co. (NYSE: KR) is making money, it reported a quarterly gross profit of $6.176 billion on quarterly revenues of $27.974 billion on 31 October 2019.
However, Kroger’s income is low. Kroger reported a quarterly income of $254 million on 31 October 2019. That number was down from $647 million on 31 October 2018.
Kroger has difficulty keeping cash, it reported a negative ending cash flow of -$84 million on 31 October 2019. Kroger cannot retain cash because of its high operating costs and the expensive new technology at the Ocado CFCs.
However, Kroger reported a quarterly operating cash flow of $771 million on 31 October 2019. That number was up from $473 million a year earlier. Thus, Kroger’s ability to generate cash is increasing, which is one reason Buffett is buying its stock.
Kroger keeps some cash. It had $1.579 billion in cash and short-term investments on 31 October 2019. That amount grew slightly from $1.527 billion on 31 October 2018.
Is Kroger a Good Dividend Stock?
Finally, I think Buffett is buying Kroger (NYSE: KR) because he considers it a good cheap dividend stock.
Kroger shares paid a 16₵ dividend on 13 February 2020. I think that’s good for a $28.23 stock. Plus, I estimate Berkshire Hathaway could make $3.04 million in dividend income from its 19 million Kroger shares.
Overall, each Kroger share offered investors a 2.27% dividend yield, an annualized payout of 64₵, and a payout ratio of 27.3% on 14 February 2020. Dividend.com credits Kroger with 11 years of dividend growth.
Thus, I think Kroger is a good stock for average investors because of its low price and dividend. I think those attributes give Kroger a high margin of safety. Kroger has a high margin of safety because you will make money from the dividend, no matter what price KR shares trade at.
Thus Kroger is worth investigating – If you are looking for a good cheap dividend stock or a Buffett value investment.
*Source: 2018 Kroger Fact Book