As a dividend growth investor, I am constantly looking for new opportunities to increase my income stream. Sometimes I add to existing positions, and other times I start new positions to expose myself to new industries or diversify further. Current market volatility can be an excellent opportunity to find companies with attractive valuations.
I lack exposure to consumer staples companies in my dividend growth portfolio. I own stock in several major retailers, including Walmart (WMT) and Target (TGT). In this article, I will analyze another retailer that I have followed for some time, Kroger (NYSE:KR). Consumer staples seem to be a safe haven for investors in volatile times due to their low volatility and steady execution.
I will analyze the company using my dividend growth stock analysis methodology. I use the same method to make it easier to compare searched companies. I will examine the fundamentals, valuation, growth opportunities and risks of the business. I will then try to determine if it is a good investment.
Seeking Alpha’s business overview shows that:
The Kroger operates as a retailer in the United States. The Company operates food and drug stores, multi-department stores, market stores and price impact warehouses. Its combined food and pharmacy stores offer natural and organic food sections, pharmacies, general merchandise, pet centers, fresh seafood and organic products, and multi-department stores offer clothing, fashion and furniture for home, outdoor living, electronics, automotive products and toys.
The company’s revenues have increased by more than 50% over the past decade. This is a compound annual growth rate of approximately 4%. The company is growing as it opens stores and expands its digital offering. While the rate of growth isn’t extraordinary, the chart below shows how steady the growth is, which is why investors flock to consumer staples during downturns. Going forward, analyst consensus, as seen on Seeking Alpha, expects Kroger to continue to grow sales at an annual rate of around 4% over the medium term.
EPS (earnings per share) has grown much faster over the past decade. EPS has increased by more than 400% in 10 years. EPS growth was achieved by increasing sales, aggressively buying back shares and improving margins. Margins are improved by using house brands and reducing costs. Going forward, analyst consensus, as seen on Seeking Alpha, expects Kroger to continue to grow EPS at an annual rate of around 3% over the medium term.
Kroger introduced the dividend 15 years ago and has increased the dividend every year since. The company is paying 2.25% following the latest 24% dividend increase. The company pays less than 30% of its profits in dividends. Therefore, the dividend looks safe and unlikely to be cut. Investors should expect the company to continue to raise it as it prioritizes returning capital to shareholders.
In addition to dividends, Kroger also returns capital to investors through redemptions. Buyouts are a great way to repay capital when businesses are growing. This is an effective way to supplement EPS growth by reducing the number of shares outstanding. Over the past decade, Kroger has repurchased almost a third, which has increased EPS by almost 50%. Buybacks are very effective when stocks are trading for a low valuation.
The company’s P/E (price to earnings) ratio comes out at 11.83 when factoring in expected 2022 EPS. It’s significantly lower than the P/E we saw just a few months ago, when the ratio peaked at 15. The current ratio is around the average ratio we saw last year. Therefore, given the growth of the business, I believe it is valued appropriately.
The chart below from FAST Graphs also implies that Kroger is reasonably valued. The company’s average P/E ratio over the past two decades was 13.45. The current P/E ratio is lower than the expected growth rate. The average growth rate over the past 20 years was 7.7%, about half of current forecasts. The harsher environment affects the growth rate. Future acceleration in EPS growth could lead to multiple expansions.
In conclusion, Kroger is a trustworthy company that continues to grow. The company is benefiting from revenue and net income growth, increased dividends and buybacks. The company is trading for what I think is a fair valuation, and investors can get an investment that combines strong fundamentals with a reasonable valuation.
Margin expansion is the first opportunity for Kroger. Retailers operate on extremely thin margins, and the struggle is to increase them. Kroger plans to improve the product line by offering more of its private label. He also plans to continue to cut costs and maintain a lean operation as much as possible. Finally, it leverages its database by using customer data to help partners market directly to them.
Balance sheet strength is another growth opportunity. The company has deleveraged its balance sheet over the past five years. This balance sheet can now support future growth through mergers and acquisitions. It can acquire competitors in regions where it has little or no presence. This strategy will shorten its path to expansion and enable faster growth in revenue and net income.
Digital and omnichannel capabilities are crucial. As consumers have higher disposable income, they are not only focused on price and demand a positive shopping experience. Kroger is investing in its digital business to attract new customers. Additionally, it will make it easier for the business to reach new markets and provide a better experience, which will lead to higher margins.
Inflation is a significant risk for retailers as they are primarily product resellers. They suffer from rising labor costs and rising prices of goods. For example, Kroger is not as big as Walmart and its bargaining power with suppliers is weaker. Therefore, the company will have to raise prices, which will make it more difficult to increase market share.
In addition, the company operates in a highly competitive business environment. It competes with companies like Walmart and Target, which enjoy better bargaining power with suppliers and greater scale, saving them money on their operations. Competition will make it harder to raise prices, and it will also make it harder to expand and conquer new markets.
Considering inflation, the tough competitive environment affects the growth rate. The expected rate of growth is slow and, although not a business risk, it is a risk for investors who may achieve higher total returns by investing in the index. The company has grown faster in the past and it has room to expand in the US, but the current environment will make it difficult for it to grow in the medium term.
Kroger is a good company with a long track record of running it efficiently. It benefits from solid fundamentals with solid growth in sales and net income. It pays a reliable dividend and constantly reduces the number of shares. The company is currently valued at fair value and presents several growth opportunities for the future and what I consider to be limited risks.
Kroger, in my opinion, is a buy for dividend growth investors looking for reliable income from a well-known retailer. However, investors should not expect the company to beat the S&P 500 over the long term. Kroger is a “slow mover” and it suits a specific type of investor who is looking for reliable, growing income.