Kroger’s (NYSE:KR) performance in recent quarters compared to its peers has left its investors unimpressed. In 2019, Kroger stock rose 5.4%. In comparison, the stocks of Target (NYSE:TGT), Walmart (NYSE:WMT), and Costco (NASDAQ:COST) surged 94%, 27.6%, and 44.3%, respectively. Kroger also lagged the benchmark index of the S&P 500, which appreciated 28.9% last year.
Amazon (NASDAQ:AMZN) has aggressively expanded in the grocery space, especially following its acquisition of Whole Foods in 2017. Increasing rivalry from Amazon has put pressure on Kroger and other supermarket chains.
According to a November 2019 CNBC report, Amazon plans to open a grocery store in Woodland Hills, near Los Angeles, this year. Wall Street analysts anticipate that this location is the first of Amazon’s plan to open its own grocery store chain. Amazon already operates stores under the Whole Foods and Amazon Go brands.
How was 2019 for Kroger?
Kroger announced its third-quarter earnings last month. Its identical sales without fuel grew 2.5% YoY. The company’s third-quarter net sales rose 0.5% YoY to $27.97 billion. Analysts estimate its net sales at $28.15 billion.
Higher sales to retail customers (without fuel) drove the company’s third-quarter sales. This was partially offset by lower supermarket fuel sales and the impact of the sales of its Turkey Hill Dairy and You Technology businesses.
Moreover, the company’s third-quarter digital sales grew by 21%. Kroger is focused on improving its digital capabilities to fight Amazon and Walmart’s robust e-commerce growth. Walmart’s third-quarter digital sales grew by an impressive 41% YoY. To boost its digital sales, Kroger has extended its pickup and delivery facilities to 1,915 and 2,326 locations, respectively.
Earnings and revenues
Kroger’s third-quarter adjusted EPS declined by 2.1% YoY to $0.47 against analysts’ estimate of $0.48. A lower operating margin impacted Kroger’s earnings.
Meanwhile, Target and Walmart reported strong third-quarter earnings. Target reported robust sales growth of 4.7% to $18.7 billion for the third quarter. Its comparable sales grew by 4.5%. Target’s adjusted EPS increased by 24.9% to $1.36, with the help of stronger margins.
Walmart’s third-quarter revenue grew 2.5% YoY to $128 billion, with a US comparable sales growth of 3.2%. Its adjusted EPS rose 7.4% to $1.16.
Overall, Kroger’s net sales declined by 0.2% YoY in the first three quarters of fiscal 2019 to $93.4 billion. Its adjusted EPS fell 0.6% to $1.62. In 2019, Kroger raised its quarterly dividend by 14% to $0.16 per share. It marked the 13th straight year of a dividend hike.
In its third-quarter press release, Kroger disclosed its intention to initiate share repurchases under its $1 billion share repurchase program during the fourth quarter. The company decided to initiate its share repurchase during the fourth quarter of 2019, as it was within its targeted debt range.
Q3 gross margin
Kroger’s third-quarter gross margin expanded about 20 basis points YoY to 22.1%. The company attributed this improvement to factors such as higher gross margin on fuel sales, growth in alternative profit stream, and lower warehousing and transportation costs as a percentage of sales. However, a decline in its pharmacy margin, investments in lower prices, and growth in the lower margin specialty pharmacy business had an adverse impact on the gross margin.
Operating margin under pressure
The company also credited Restock Kroger for the slight improvement in gross margin and the strong comparable sales. Restock Kroger’s cost-saving initiatives led to a reduction of 15 basis points in the company’s OG&A (operating, general, and administrative expenses) rate, excluding fuel and adjustments.
Despite the cost savings, Kroger’s reported OG&A rate increased to 18.2% in the third quarter of fiscal 2019 compared to about 16.8% in the third quarter of fiscal 2018. The factors that led to a higher OG&A rate included increased investment in digital growth and a rise in incentive plan costs.
However, the company’s third-quarter operating margin contracted 142 basis points YoY to 0.91%. The positive impact of higher gross margin on its operating margin was offset by a higher OG&A rate as well as its increased depreciation and amortization expenses rate.
Kroger’s strategic alliances
Kroger entered several collaborations and launched strategic initiatives in the past year. These steps aim to boost Kroger’s foot traffic, improving its sales. Kroger partnered with tech giant Microsoft (NASDAQ:MSFT) by leveraging Kroger Technology products developed over the Microsoft Azure platform. The retailer plans to utilize Microsoft Azure and Azure AI to create a connected store experience.
Plus, the partnership plans to market a commercial form of RaaS (Retail-as-a-Service) product to the retail industry. Kroger’s technology team has already developed a smart technology system, connected by IoT (Internet-of-Things) sensors to transform two stores in Ohio and Washington. This store transformation would be implemented on a pilot basis.
Working with Walgreens
Kroger also formed a retail procurement alliance with Walgreens (NASDAQ:WBA). This alliance is an extension of the strategic collaboration announced in October 2018. This alliance aims to create supply chain efficiencies through the utilization of the partners’ collective resources.
Another notable collaboration is with British online grocery retailer Ocado. Under this collaboration, the two entities are building automated warehouses.
As of January 7, Kroger was trading at a 12-month forward PE (price-to-earnings) multiple of 12.3x. Meanwhile, its closest peers Walmart, Target, and Costco were trading at forward PE multiples of 22.4x, 17.9x, and 32.9x, respectively.
Kroger is currently trading at a lower forward valuation multiple compared to its peers. Analysts expect Kroger’s adjusted EPS to rise 3.8% in fiscal 2019 and 6.4% in fiscal 2020. They expect Walmart and Target’s adjusted EPS to rise 1.8% and 18.7%, respectively, in the current fiscal year. They expect its adjusted EPS to rise 4.4% and 8.4%, respectively, in the next fiscal year. Analysts also forecast Costco’s adjusted EPS to increase by 5.1% in fiscal 2020 and 8.0% in fiscal 2021.
Outlook for 2020
Kroger has projected improvement in most of its performance metrics for fiscal 2020. The grocery retailer expects its fiscal 2020 identical sales growth to be higher than 2.25%. It expects fiscal 2019 identical sales growth of 2.0%–2.25%.
This projection pegs its fiscal 2020 adjusted EPS to be $2.30–$2.40 for fiscal 2020. For the current fiscal year, Kroger expects adjusted EPS of $2.15–$2.25.
Kroger also expects its fiscal 2020 operating profit to improve to $3.0 billion–$3.1 billion with an incremental alternative profit of $125 million–$150 million. The company projected free cash flow of $1.6 billion–$1.8 billion, which would give it room for a dividend hike in fiscal 2020 as well. Kroger plans to repurchase shares worth $500 million–$1.0 billion in fiscal 2020.
Do analysts expect Kroger stock to rise?
Analysts have maintained a moderately bullish view of Kroger’s stock. Ten out of 23 analysts have rated the stock as a “buy.” Eleven analysts have recommended it as a “hold,” and two analysts have a “sell” rating.
Currently, analysts have estimated a target price of $27.90, with a potential downside of 2% over the next 12 months. As of January 7, Kroger stock has declined 1.4% so far in 2020.
Currently, Kroger lags in strategic areas of value pricing and digital expansion in comparison to Target and Walmart. The company expects to improve its earnings and profitability in the upcoming quarters through its tech-based initiatives and strategic collaborations. Also, the company’s focus on its private brands, including Simple Truth, could boost its growth.