Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Grocery Wars

Is Kroger the Best Value in Retail?

The Amazon (NASDAQ: AMZN) acquisition of Whole Foods Market (NASDAQ: WFM) might make Kroger (NYSE: KR) the best value buy in retail. Kroger stock was trading at $22.65 a share on June 26, 2017, yet it reported $117.02 billion in revenues on April 30, 2017.

Kroger’s revenues grew by $1.68 billion during the last quarter, yet its stock lost nearly $8 a share in value after news about the Amazon/Whole Foods deal broke. Kroger was trading at $30.32 a share on June 13, 2017 but it fell to $22.29 a share on June 16 and stayed close to that number

This does not prove that Amazon is the future of groceries and Kroger is doomed as investors claim. Instead all it proves is that investors simply do not understand the grocery business, if they did Kroger’s share value would be increasing.

Kroger is winning the Grocery Wars

The strangest aspect of this drama is that Kroger is the reason Amazon bought Whole Foods in the first place. Whole Foods share owners decided to sell the company; which was struggling with a shrinking income, because it was unable to compete with Kroger.

Kroger had successfully replicated Whole Foods business model of marketing organic and natural products and selling readymade hot entrees. More importantly its revenues and vast footprint gave Kroger the ability to undercut Whole Foods prices. To top it off Kroger can give consumers a wide variety of amenities that Whole Foods lacks including fuel, pharmacies, dry goods and in some markets jewelry stores.

Part of the reason Amazon bought Whole Foods is to counter Kroger’s entrance into its business of online retail and delivery. Kroger has been rolling out its Home Shop same delivery service in a number of markets and experimenting with delivery by Uber. It is also experimenting with click and pull or online ordering of groceries from its stores.

Basically Amazon is trying to become more like Kroger and Kroger is becoming more like Amazon. That makes Kroger a pretty good value investment because it has some of the same capabilities as Amazon at a far lower stock price.

Is Kroger a Value Investment?

Kroger certainly has some of the classic value investment criteria; it is a good stock that is misunderstood by the market, and it operates in a business that is neither fashionable nor sexy. That means we need to ask the important question does Amazon make money?

The answer is yes but it’s making less money than before. Kroger’s net income fell by $377 million during the quarter that ended on April 30, 2017. Ycharts data indicates that Kroger reported $1.96 billion in revenues on January 31, 2017 that fell to $1.583 billion just three months later. Kroger reported $2.1 billion in income for April 2017, meaning that it is making less money than last year.

The major reason for this is falling food and grocery prices, in other words deflation. That means Kroger has to sell more food to make less money, a problem that other grocers are also struggling with. Whole Foods’ net income fell by $108 million during the 12 months between March 2016 and 2017. Whole Foods reported $510 billion in net income for first quarter 2016 and $402 million a year later.

This brings grocers’ status as a value investment under serious question because they are struggling to make money right now. It should also have Amazon investors asking some serious questions.

Can Grocers Make Money?

Kroger and Whole Foods income figures raise serious doubts about Amazon’s latest acquisition. Why is the Everything Store entering a business where income is falling and even great companies like Kroger and Whole Foods are struggling to make money?

My guess is that Amazon is entering the business right now because it is cheap. Bezos bought Whole Foods because he was able to pick it up for just $13 billion, which kept Whole Foods out of the hands of Kroger or its archrivals Safeway and Walmart (NYSE: WMT).

Expect to see Amazon make several more grocery acquisitions; possibly Sprouts Farmers Market (NASDAQ: SFM) Whole Foods’ closest competitor, Safeway, Instacart or a regional grocer such as Winn Dixie. Another potential target is BJ’s Wholesale Club, which is supposedly for sale.

Is Kroger Making Money?

Kroger is making money but its financial statement is a mixed bag. The company reported an .84% profit margin on April 30, but it is generating some cash.

Kroger reported a free cash flow of $1.491 billion, cash and short-term investments of $356 million and $4.528 billion in cash from operations on the same day. It also reported assets of $35.08 billion and an enterprise value of $33.46 billion.

My take is that Kroger is a good retail investment if you can stomach the low profit margin. Its investors did take home a 12¢ dividend on May 11, and enjoyed a 24.41% return on equity on April 30, 2017.

If you are looking for a bargain in the retail sphere Kroger is certainly worth a look. Unfortunately it’s a stock that is likely to remain underpriced until food and/or fuel prices increase substantially. Since I don’t expect that to happen any time soon, expect Kroger share price to remain low for the foreseeable future no matter what Amazon does.