Morningstar | Kroger Remains on Track to Hit Our Targets After Its First Quarter; Shares Attractive
We do not plan a large change for our $28.50 per share valuation for narrow-moat Kroger after it posted first-quarter earnings that leave it on pace to meet our full-year targets. We similarly do not anticipate altering our long-term outlook, calling for low-single-digit top-line growth against 4% adjusted EBITDA margins on average over the next 10 years. We see the shares as somewhat attractive, with patient investors willing to wait for Kroger’s efficiency improvement efforts to take hold likely to be rewarded.Revenue fell 1.2% on 1.5% identical sales growth (excluding fuel), against a 2.4% operating margin. Management still calls for 2%-2.25% identical sales growth (excluding fuel) and adjusted diluted EPS of $2.15-$2.25, consistent with our 2.3% and $2.20 targets.
While identical sales lagged our full-year mark, we are encouraged by management’s indications that the second quarter has been closer to full-year guidance thus far. Kroger’s own brands helped the performance, with private label sales up 3.3%. Growth was driven by Kroger’s more premium labels, including Simple Truth (which showed double-digit percentage expansion) and Private Selection. This is consistent with our view that Kroger can use its own labels as a facet of its response to intense category competition, drawing customers into the store with a high-quality lineup. Management indicates that margins on its own labels are 600-800 basis points higher than their national brand counterparts, which we believe will provide headroom for Kroger even as price pressure remains relentless.
The firm also indicated that its alternative profit streams (which include data and media analytics, gift cards, and personal finance products) are performing well, with management expecting them to provide about $100 million in incremental operating profit for the year. We believe such relatively high-margin and asset-light businesses can support Kroger’s performance despite challenging industry dynamics.
Kroger operates as a retailer. The company also manufacture and process some of the food for sale in its supermarkets. Supermarkets are operated under one of the following formats: combination food and drug stores (combo stores); multi-department stores; marketplace stores; or price impact warehouses. The combo stores provide food and organic sections, pharmacies, general merchandise, pet centers and perishables such as seafood and organic produce. Marketplace provide grocery, pharmacy and health and beauty care departments as well as perishable offering and general merchandise area that includes apparel, home goods and toys.
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