Why Kroger is (Still) a Strong Buy
Summary
Amid the backdrop of strong economic fundamentals, retail sales have begun to accelerate. This has led to strong outperformance from retail stocks over the last six months.
Consumer staple retailers have led the sector, with KR, CASY, IMKTA, CVS, and WFM leading the group especially.
Kroger is the most attractive of these stocks, as it combines strong growth metrics with a still attractive valuation.
The average analyst rating on Kroger is a Buy, yet the average price target is below the current price. Expect the recent slew of analyst price target raises to continue.
A) Introduction
With the unemployment rate close to 5.5% and quarterly GDP growth being revised up to 5%, retail sales growth has begun to accelerate. This acceleration can be seen in the chart below, in which there has been a clear pickup in retail sales growth since November of 2013:
Source: Trading View
The market has started to wake up to the retail sector comeback, leading to strong outperformance from retail stocks over the last six months. This is shown below, as the S&P 500 retail industry group returned over 11% while the S&P 500 returned less than 4%:
Chart courtesy of StockCharts.com
One group that has done particularly well during this stretch are consumer staple retailers, with Kroger (NYSE:KR), Ingles Markets (NASDAQ:IMKTA), Casey's General Stores (NASDAQ:CASY), CVS Caremark Corporation (NYSE:CVS) and Whole Foods Market (NASDAQ:WFM) all up 25% in the last six months. Of these stocks, we believe Kroger offers the best combination of growth, value, and price momentum. Kroger operates 2,450 supermarkets and department stores, of which 1,090 are also fuel centers. Opposite to what many believe, fuel center companys benefit from lower energy prices as their main costs decrease dramatically at the same time that demand increases. Additionally, lower gas prices amount to a giant tax break for consumers, which should lead to increased overall retail spending. Kroger is positioned well to capitalize on these trends.
In this report, we'll break down Kroger's valuation relative to industry peers, their growth profile, how their earnings performed versus analyst expectations, and other important metrics to watch. We restrict our analysis focus to solely the metrics that have a long historical record of predicting stock returns, thus focusing mainly on relative value, price momentum, and earnings growth rates.
B) Valuation Breakdown
Anyone who has back tested historical stock data knows that undervalued stocks consistently beat overvalued stocks by a wide margin. We'll start by comparing five value metrics that have each been shown to predict stock returns. This table is shown below:
Out of the five valuation ratios shown above, Kroger looks the most attractive on a revenue basis. Kroger sports a sales yield (inverse of Price/Sales) of 333%, meaning investors can get $3.33 of revenue for every $1 invested into the stock. This is much higher than the Food & Staples retailer industry group average (153%), and overall Consumer Staple sector average (36%). Kroger's earnings yield is also moderately attractive at 4.92%, which is more than double its industry group average (2.27%) and more than triple the sector average (1.36%). With that being said, Kroger looks relatively overvalued on a dividend and book value basis, with both of each in the bottom 20% of the entire market. Overall, our algorithms rate Kroger as slightly undervalued and expect the stock to outperform the market by 1.01% due to this undervaluation.
C) Growth Breakdown
Similar to value, growth and momentum have been repeatedly shown to predict stock returns. There are many possible explanations for this anomaly, but what matters is that winning stocks tend to keep winning and vice versa. Thus, we'll analyze five growth metrics that have each been shown to predict stock returns. This table is shown below:
Kroger's six-month (+36%) and 12-month price change (+70%) is in the top decile of the entire market. It is also important to note that the food & staples retailing industry group six-month price performance (+19%), is more than double the overall sector average (+7.4%). Krogers annual EPS growth isn't as strong (+4.7%), trailing behind the industry group (+22%) and overall sector averages (+26%). Kroger also outperforms on profit efficiency, returning 32% on equity compared to 15% for the industry group average. Overall, our algorithms rate Kroger as a "Strong Growth" company, and expect the company to outperform the market by 7.17% over the next twelve months because of it.
D) Conclusion
Kroger combines solid undervaluation with strong momentum and growth, and strong industry tailwinds (retail comeback). Overall, our algorithms expect the stock to outperform the market by 8.17% over the next twelve months with 1.01% due to relative undervaluation and 7.17% due to strong growth metrics.
Wall Street agrees with our optimism, as the average recommendation on the stock is also a Buy. With that being said, the average 12-month Wall Street price target is actually negative for the stock at $65.28 (-1% from current price). To figure out why the 12-month price target was so low, we looked through each of the analyst price targets on the stock. Interestingly enough, most of the bearish price targets are simply outdated, as shown below:
Source: TipRanks
If these analysts update their price targets and recommendations to Kroger's rising price, we should see a rush of price target raises on the way. This has already started to happen, with three price target raises in December alone. We feel this is another potential tailwind for Kroger's stock price. Quantified Alpha Research Kroger Recommendation: "Strong Buy".
