Competition in the supermarket industry has been especially ferocious during the recession, as chains have consistently lowered prices to gain market share for cash strapped consumers. For Kroger (KR), the industry’s largest US chain, the troubles intensified in the second half of last year as they missed analysts’ estimates by a notable margin in the previous two quarters. However, in their fiscal fourth quarter the company earned $255.4 million or $.39 cents per share, which exceeded consensus estimates by a nickel. Profits have dropped 27% from a year ago, even though overall sales rose 7% to $18.6 billion. In this quarter, sales were boosted primarily by fuel offered at a discount to grocery shoppers, and excluding fuel sales rose by a more modest 2%. Same store sales also increased by 1.2%, but did project 2% to 3% same store sales growth in the year ahead, excluding fuel.
As for the year ahead, Kroger did lift the upper end of earnings guidance to $1.60 to $1.80 from $1.60 to $1.70, but this is still considered conservative considering consensus analysts’ estimates were calling for $1.79. Management blamed the cautious outlook on general economic uncertainty, continued competitive pricing pressures, possible inflation or deflation, as well as the potential influence of fluctuating fuel margins. In general, the size of Kroger’s operations may make it better able to handle some of these evolving factors than would a smaller chain, but uncertainty is not a friend to investors and the stock is sold off this morning by more than 2%. However, the stock quickly recovered to about even in relatively heavy morning trading.
At this time, we are confident to reiterate our Fairly Valued rating on KR based on the latest earnings data. The stock currently trades comfortably within its historical price-to-cash earnings range of 7.3x to 10.2x. Price-to-sales for the year just ended was only .19x compared to the markets historically normal valuation of .22x to .31x. Based on our methodology, it is clear that the stock is closer to undervalued than it is to overvalued, and at the current fundamentals we would expect a price of about $25. However, Kroger’s management remains cautious for the year ahead, and we think the stock is priced appropriately for the expected market conditions.
