In February this year, Warren Buffett bought $549 million in Kroger (KR) shares. After the announcement, investors followed and Kroger’s shares up more than 5%.
The perfect combination of Supermarket Stock and Undervalued Stock?
In fact, supermarket companies have always been favored by Mr. Buffett, including Wal Mart and Costco. However, in the third quarter of 2018, after more than 20 years of holding positions, Warren Buffett cleared Wal Mart; for Costco, Mr. Munger, Mr. Buffett’s partner, even called it “the enterprise that most wants to bring into the coffin.”.
Kroger, the largest supermarket chain operator in the United States, is also the second largest retailer after Wal Mart.
Moreover, Kroger is not an expensive stock compared with the whole stock market. Assuming that Berkshire built a position in the early fourth quarter, when Kroger’s price was around $25, it was only 12 to 13 times the expected earnings, far below the 15 to 20 times valuation of most S & P 500 companies.
The reason for the low valuation is that Kroger, like other retailers, has faced fierce competition from Wal Mart, Amazon and target in recent years. Since reaching an all-time high of nearly $42 in 2015, Kroger’s share price has continued to decline, falling below $20 twice. Its 52 week share price ranges from $20.7 to $29.97, with a current market value of $22.6 billion.
Although Mr. Buffett’s past investment record is good, it is reasonable for investors to follow his operation, but even Buffett himself has regretted the stock he bought. Last year, for example, he admitted that the price he paid for Kraft in 2015 was too high. It’s a good business, but sometimes it’s expensive.
So even if Mr. Buffett is so successful, investors should not blindly follow his every move.
Let’s analyze whether ordinary investors should buy Kroger shares now.
Before Mr. Buffett bought it, Kroger’s shares fell about 4% in the past year, seriously underperforming the market. Wall Street believes that Kroger faces price competition from Wal Mart ($WMT) and Aldi on the one hand, and continues to increase investment in online infrastructure to block Amazon’s attack.
Kroger’s Transition Pains
Compared with its peers, Kroger’s online sales start is obviously much slower.
Under the great changes in the retail environment, the old supermarket operator with a history of nearly 140 years ended its ten-year same store sales growth trend in 2017. In fiscal year 2017, its same store sales further declined from 1.1% in 2016, only 0.1%, nearly stagnating.
In the same year, Kroger launched a $9 billion transformation plan. Over the past three years, the company has overhauled its stores, promoted its online grocery business, invested in digital technology, made layoffs, and refocused its operations on the grocery business, which accounts for about 75% of sales.
But transformation takes time, and it is bound to be accompanied by pain. In early December, Kroger’s quarterly results showed that its profits had fallen for the fifth consecutive quarter, with a year-on-year decline of 17% to $263 million. In addition, Kroger’s same store sales growth of just over 2% is still lower than Wal Mart’s and target’s 3% — 5% growth.
As a result, Kroger had to slow down the pace of renovating its stores and laid off nearly 1000 more jobs in October last year, the largest layoff since 2017.
The dawn? Sales growth is expected to accelerate this year
However, value investors like Mr. Buffett are certainly more concerned about the long-term benefits of corporate transformation.
Some market people are beginning to see some signs that Kroger’s transformation plan is beginning to show its effectiveness. For example, on the investor day at the end of last year, Kroger issued a positive guidance for fiscal year 2020. It is expected that the same store sales excluding fuel will increase by more than 2.25%, which is further accelerated from 2.0% to 2.25% in 2019; meanwhile, the adjusted earnings per share expectation is raised from $2.30 to $2.40, which is higher than the analyst’s expected $2.30.
In addition, Kroger also has a certain price advantage. In terms of groceries, Kroger’s average price is only 1.6% higher than Amazon’s and smaller than Wal Mart’s, according to profitero, an e-commerce analyst Jet.com 5%, Wal Mart 6.2% and target 11.6%.
On the return to shareholders, Kroger has a dividend yield of 2.2%, and plans to buy back shares worth $500 million to $1 billion in fiscal year 2020.
Stable customer demand and low inflation are conducive to the development of Kroger. But Kroger’s increased investment in the construction of automated storage equipment will erode profits. Kroger plans to build 20 distribution centers, with three expected to be put into operation next year, which is too slow.
Kroger’s management is very optimistic. In the last quarter, same store sales grew by 2.5%, the highest level since Kroger started its restock Kroger program. Management is also optimistic about the outlook for the next year, with same store sales expected to grow by 2.25% in fiscal year 2020. In addition, the company has approved a new $1 billion Share Buyback program
The market and management have different opinions, so which side is right?
Clearly, Mr. Buffett is on the management side.
Kroger’s business is still strong, and its operation level is improving. On the surface, Mr. Buffett bought a 2.3% stake in a large supermarket chain with attractive valuations. Maybe it’s not as cheap as some of the stocks he bought before, but the expected P / E ratio is only 13 times, and the valuation is only a small part of its sales, so Kroger’s valuation still has a discount.
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