Kroger Bags Steady Growth As Other Grocers Struggle

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Wander through just about any decent-sized neighborhood in the U.S. and you're likely to see a half-dozen or so different supermarkets, all selling pretty much the same stuff in similar environments.

There might be differences in the way supermarkets price and display their products. But they all sell the usual assortment of fresh produce, canned goods, meat products, frozen items, dairy products, paper goods, prepared foods, grains and dry goods.

They also face many of the same challenges: volatile food prices, fickle consumers, heavy competition and thin margins.

Yet some supermarket chains are in a constant struggle to deliver consistent financial growth, while others seem to cruise along with quarter after quarter of solid sales and earnings gains.

Prominent among the latter group isKroger ( KR ). It's the nation's largest traditional supermarket chain, with more than 2,400 stores in 31 states, and the second-biggest food retailer overall behindWal-Mart ( WMT ).

Kroger gets the vast majority of its business from its supermarket business, which includes the Kroger, Ralphs and other chains. It also operates nearly 800 convenience stores, 328 fine jewelry stores, 1,169 supermarket fuel centers and 37 food-processing plants in the U.S.

EPS Growth

While other traditional supermarket operators have struggled to produce consistent financial growth over the last couple of years, Kroger has strung together 11 straight quarters of sales and earnings gains. Eight times during that span the company has delivered double-digit EPS growth.

That's a pretty good record, considering the industry's recent struggles with an uncertain economy and unpredictable food prices.

One reason Kroger has fared so well is that it has taken an active approach to building market share and improving its customer experience through discount programs and other initiatives, analysts say.

"(Kroger) has been regaining lost market share through its tuck-in acquisitions as well as by tailoring its product and service offerings to customers' purchasing behaviors and patterns," noted Deborah Weinswig, an analyst at Citigroup.

On the operational side, Kroger has run off an industry-leading 37 straight quarters of positive same-store sales growth while still maintaining decent operating margins.

Analysts expect that run to continue as macro trends move into the grocery industry's favor.

Jeffrey Thomison, an analyst at Hilliard Lyons, says easing inflation of food prices and an improving economy will benefit Kroger in coming quarters. So will the company's ongoing investments in improved operations and efforts to contain costs.

"We expect the current year to produce further gains in (same-store) sales, easing gross margin pressure and steady operating margin," Thomison said.

A lower inflation rate should have a particularly beneficial impact on supermarket operators like Kroger andSafeway ( SWY ), which operates more than 1,600 supermarkets in the U.S. and Canada.

Ken Goldman, an analyst at JPMorgan, notes that food retailers tend to do better during periods of low and stable inflation. Over the last five years, the industry has suffered from a volatile inflationary environment, caused by either too much inflation or steep deflation.

During periods of significant inflation, some grocers suffered volume losses because consumers couldn't absorb the price increases, Goldman says. In periods of deflation, certain grocers were hurt because volume increases were not enough to offset lower prices.

The good news for Kroger and other grocers is that inflation should be much more stable over the next couple of years.

"We expect a more moderate inflationary environment for retailers through at least 2013 and potentially into 2014," Goldman noted.

The wild card is how the industry's fierce competition will impact prices. Kroger not only competes against existing traditional grocers. It also bumps up against a steady flow of new entrants as well as big-box retailers like Wal-Mart and specialty grocers such asWhole Foods Market ( WFM ).

"Due to the overall competitiveness of the food retail industry, we still believe a promotional environment may be necessary to protect market share," Goldman said.

Even with the prospect of low inflation, he added, "it may be too early to become highly optimistic on traditional grocers' margins."

Margin Growth

Indeed, Kroger posted a lower year-to-year gross margin during its 2012 fourth quarter, which ended Feb. 2.

But the company still managed to deliver earnings of 77 cents a share, excluding special items such as the benefit of an extra week in the quarter. That was up from 50 cents the prior year and above consensus estimates for 70 cents.

Sales for the quarter gained 13% to $24.2 billion, slightly above views. Same-store sales excluding fuel climbed 3%.

Analyst Thomison cited several encouraging developments during the quarter, including improvement in the number of visits per household and the number of units per basket. Kroger also saw more sales of its own store-brand goods.

"Company-branded products represented about one-third of grocery units sold, reflecting considerable success with Kroger's Simple Truth and Simple Truth Organic brands," Thomison said.

Meanwhile, the company's strong cash flow might lead to more acquisitions in coming quarters.

"We believe acquisitions are a possible use of free cash flow in 2013 but have not factored any into our outlook," Thomison noted.

Kroger is scheduled to report its fiscal second-quarter earnings on June 20. Analysts polled by Thomson Reuters expect profit to come in at 88 cents a share, up from 78 cents a year earlier.

The company's stock price touched a record high of 35.42 on May 17 and currently trades near 35.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: KR , SWY , WFM , WMT

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