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Kroger Co. (KR)

This grocery store continues to be a model of efficiency and profit, beating estimates, and increasing guidance. In the past 30 days, 16 analysts have increased their earnings forecasts for the company.

Kroger Co. (KR)

We believe that Kroger (KR) is differentiating itself by delivering consistent sales and earnings growth in a very volatile retail sector. Kroger has been a leader in using rigorous data analysis to offer personalized promotions, in recognizing the need to offer low and compelling prices, and in efficiently managing operations to enable the price investments that drive market share.

On September 11, Kroger reported a 26% increase in fiscal 2Q earnings, to $0.44 per share. EPS topped the consensus of $0.39 and our estimate of $0.39. Excluding fuel, total sales rose 5.7%.

Identical-supermarket sales, which exclude fuel, rose an impressive 5.3%, which was above the StreetAccount consensus forecast of 4.5% growth. Kroger posted growth in every department and division. This was the 47th consecutive quarter of higher identical-store sales.

Management has raised its FY16 EPS guidance to a split-adjusted $1.92-$1.98 from a prior $1.90-$1.95, and its guidance for identical supermarket sales growth by 50 basis points to 4%-5%.

We believe that management’s focus on delivering value to shoppers will continue to boost market share in an economic environment that is improving, but still challenging for some customers. The company has increased identical-store sales for 46 consecutive quarters and management has been working to strengthen customer relationships through value pricing. It is also using data analysis to offer targeted coupons and rewards to its best customers. In February 2014, a customer downloaded KR’s one billionth digital coupon. Reaching that milestone took four years. Going from 1 billion to 2 billion coupons took just 15 months. With a value proposition and strong customer relationships firmly established, management is aiming to accelerate earnings growth with increasing capital investments.

We believe that the recent purchase of Harris Teeter adds an excellent store operator in the Southeast, a complementary geographic region for Kroger. On a trailing basis, Harris Teeter had a higher premerger operating margin than Kroger. We also believe that the proposed acquisition of Vitacost.com will expedite Kroger’s e-commerce presence and accelerate its growth in natural and healthy foods.

We see upside in KR shares and are increasingly optimistic about management’s plan to accelerate earnings growth. We have raised our five-year growth forecast three times since 2012. The most recent increase came amid increasing evidence of management’s ability to raise operating margins and profit from incremental capital investments.

Kroger has a record of returning cash to shareholders. Through 4Q15, the company had raised its dividend at a compound annual rate of 16% over the previous three years and repurchased about $1.3 billion of its stock last year. On June 25, the company increased the dividend by 13.5%, authorized a new $500 million buyback plan, and announced a 2-for-1 stock split that took effect on July 13, 2015.

We are raising our one-year price objective to $43 from $42. The increase is based primarily on our higher EBIT estimate for the next four quarters. Kroger shares have returned approximately 45% in the last year. The shares are trading at 19.0-times our FY16 EPS estimate and at 17.0-times our FY17 forecast. Kroger is trading at 19-times the current-year consensus earnings forecast, in line with the average multiple of 18 for a group of food retailers tracked by Bloomberg. We believe that a premium multiple is justified based on the company’s consistent increases in comp sales and market share.

Kroger is currently trading at an enterprise value of 14-times trailing EBIT. Safeway, which had a buyout offer, had been trading at 17-times. The peer median for retailers in our universe is 14-times, according to Bloomberg. We believe that KR is worth more than the peer average based on its very consistent comp growth.

Jim Kelleher, CFA, Argus Weekly Staff Report, www.argusresearch.com, 212-425-7500, September 21, 2015