Personal Finance

Are Investors Too Bearish on Kroger?

A woman shopping in a grocery store aisle.

Once a high-flying turnaround story, Kroger (NYSE: KR) can't seem to catch a break. In the wake of the great recession, Kroger used the time to reinvent itself and saw its shares rocket up more than 240% by 2016. Since then, however, it's been a tougher run and shares have been nearly cut in half as the company reported shrinking comparable-sales growth figures, even as the company has produced five consecutive quarters of top and bottom-line beats or matches.

Kroger's recently reported fourth-quarter earnings brought more of the same. The company modestly beat analyst expectations on the top line with revenue of $31.03 billion versus an estimate of $30.83 billion and matched adjusted earnings per share at $0.63. And keeping in line with Kroger's performance, shares sold off again -- this time to the tune of 12% . Are investors being too bearish?

A woman shopping in a grocery store aisle.

Image source: Getty Images.

Tax cuts were supposed to increase equity prices

Although Kroger reported a decent quarter, there were a few issues that concerned investors. The first is decreased margins. Traditionally, grocery is a cutthroat business on margins with the expectation that better operators can make a profit on scale. Kroger disappointed investors this quarter by reporting a 21.9% gross margin percentage, 31 basis points lower than in the prior year.

However, the biggest concerns were about the company's guidance and the beneficiaries of the corporate tax cut. Kroger expects to earn $2.05 per share this fiscal year at the midpoint -- lower than most analysts had estimated. The difference appears to be that the company is planning to invest in its store and its employees under the Restock Kroger initiative instead of the entire tax-cut benefit going to shareholders.

Management noted that one-third of the benefit would go to employees, one-third would go to capital investment, and the other third would go to shareholders. It was the light guidance amid increased investment in human capital and capital expenditures that shaved off more than $2 billion in Kroger's market cap.

The bearish thesis for Kroger seems overblown

Another reason that investors have been bearish may never materialize. The bulk of Kroger's recent stock swoon concerns the /Whole Foods acquisition: The day the merger was announced Kroger plunged 9%. While Amazon has recently committed more efforts to integration, with its VP of Amazon Prime now spending more time with the Whole Foods division , to date, the combination has not been a significant disruptor to the grocery industry.

The upshot for investors is that due to concerns about margins, capital allocation, and competition, they're getting a cheap stock that's growing its top line at 12% year over year. Shares of Kroger now trade at 10.7 times forward earnings versus the greater S&P 500's valuation of 17.2 times

Moreover, these concerns seem overblown, at least at this point. As for the first two: The recently enacted corporate tax cut will afford Kroger the latitude to invest in the company (potentially lowering gross margins) while still growing its bottom line. As for the last, the grocery industry is certainly large enough to accommodate the rise of Amazon/Whole Foods and Kroger, even if the former becomes disruptive.

In my opinion, the market is too bearish on Kroger considering its performance. Whether you should buy or not depends on your investing time frame. If you're looking for a long-term, multi-decade buy, it's likely you're in the wrong industry if you're looking at a pure-play grocer. However, if you're looking for a mispriced stock with the potential to take off once Wall Street regains its senses, put Kroger on your watchlist.

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Jamal Carnette, CFA has no position in any of the stocks mentioned. The Motley Fool is short shares of Kroger. The Motley Fool has a disclosure policy .

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

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

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