I’m eating a lot less meat these days. I don’t eat a lot of meat anyway, but do occasionally enjoy a hamburger, spaghetti, or chicken on the grill. And when ground beef went to $6.99 a pound, and chicken to $10 for three breasts (instead of $3.99), I began to reduce my meat purchases. And now with ground beef more than $9 a pound, and chicken more than $6, I’m pretty much a vegetarian these days.
I haven’t thought about grocery stocks for a while. I’ve been a past owner of both Kroger (KR) and Costco (COST), as well as Walmart (WMT) stocks. But I’ve been out of that sector for some time.
However, today, I saw a report that Kroger was spending $1.65 billion (in cash and debt assumption) to buy privately held Giant Foods, a company with 197 supermarkets and 11 standalone pharmacies in northern Ohio, western Pennsylvania, West Virginia, Maryland and Indiana. I thought, hmm. I was curious as to what catalyst prompted that, so I decided to take a look at the sector.
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A recent report by the U.S. Bureau of Labor Statistics showed that food prices in the U.S. are 3.1% higher than a year ago. The stats say that food-at-home (grocery) prices have risen 2.7%, while food-away-from-home (dining out) prices have risen 3.5%.
The following chart illustrates how prices of the major food groups have risen over the past 20 years.
Source: U.S. Bureau of Labor Statistics
So, my primary question was this: With food inflation running rampant, are the grocers keeping more of that windfall, which would lead to improving margins (meaning they are making more money per dollar of sales)? Is that what is attracting Kroger to the deal?
It’s possible, but both companies run on EBIT (earnings before interest and taxes) at around 2%-2.5%, although local legend says that Giant Eagle prices are higher than Kroger’s. Kroger saw its EBIT decline through this inflationary period, but recent reports indicate it is once more on the rise.
Kroger says the transaction will improve its market share in adjacent markets to its existing stores. That makes sense.
So, I wanted to know, did this transaction improve Kroger’s stock potential?
Analyzing Grocers
There are several ratios that analysts commonly use to analyze grocery stocks:
Price to Earnings Ratio, which shows how much investors are willing to pay for each unit of earnings. Grocery stocks operate on very thin margins and usually have lower multiples than higher-growth sectors. Think of them as the tortoise versus the hare. Kroger’s P/E is 32.89; the sector’s average P/E is around 20x.
Price to Sales Ratio. A lower ratio can mean the stock is undervalued, but only if the company has strong fundamentals. Kroger has a P/S ratio of 0.24; the industry average is currently 0.38.
Dividend Yield. Most grocers, due to their stable cash flows, pay dividends. Kroger has a dividend yield of 2.59%; the industry average is 1.87%.
Kroger is currently trading around 56/share. Its 52-week range is 54.15 - 76.58, with analysts predicting a target price of around 71.
All in all, Kroger looks like a decent buy at current prices. But my research also led me to a couple of other grocery stocks that look interesting at this time:
Ingles Markets Inc. (IMKTA), headquartered in Asheville, NC, operates 200 or so supermarkets in the Appalachian region of the U.S., specifically in North Carolina, South Carolina, Georgia, Tennessee, Virginia, and Alabama. Its P/E is 16.32x and its dividend yield is 0.74%.
Weis Markets (WMK), headquartered in Sunbury, PA, has 204 locations in Pennsylvania, Maryland, New York, New Jersey, West Virginia, Virginia, and Delaware. The stock trades at a P/E of 19.71 and has a dividend yield of 1.74%.
While none of these stocks are probably going to make you rich overnight, there’s something to be said for growing, conservative cash flow.
And right now, there are a few catalysts that make the grocery industry attractive, including:
Inflation, which makes eating at home more economical.
Regional M&A activity is rising, so look for more deals like the Kroger/Giant Foods buyout in the near future.
Supply chain consolidations are improving efficiency.
Rising digital e-commerce adoption is making margins more attractive.
Loyal, membership-based pricing models are increasing profitability.
Since we’re already spending so much more money to eat, why not earn a bit by investing in the industry?
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