TipRanks Smart Dividend Newsletter – Edition #10
Hello and welcome to the tenth edition of TipRanks’ Smart Dividend – a weekly Newsletter providing you with investment ideas for safe-bet quality stocks that are outstanding dividend payers, compared to their peers.
Today’s dividend stock recommendation is one of the largest retailers in the world, which has been raising its dividends consistently for the past 17 years. The company’s stock is now trading at a considerable discount to its peers, presenting a great entry point for investors.
But first, let’s delve into a short update on the market developments.
Stock Markets: Fresh Cash for Everyone
Investing in grocery retail stocks presents a robust opportunity for income investors seeking consistent returns. First and foremost, grocery stores operate within the non-discretionary sector, offering everyday essential items which consumers purchase irrespective of economic cycles. This stable demand translates to consistent revenue, supporting attractive dividend yields for investors, even during economic downturns.
Another compelling reason for income investors to consider grocery retail stocks lies in their inflation-hedging properties. As the cost of goods rises, grocery retailers pass on these increased costs to consumers, ensuring their profit margins remain protected. This feature makes grocery retail stocks a solid defensive asset in an inflationary environment, thereby ensuring the preservation of income for investors. On the other hand, in periods of decreasing inflation, grocery retail stocks still offer compelling advantages. As inflation declines, the overall cost of goods sold typically decreases, thus reducing the input costs for grocery retailers. They can take advantage of these lower costs to improve their profit margins or to offer competitive pricing to consumers.
In an increasingly digital world, many grocery retailers have capitalized on technology to expand their revenue streams. Through online shopping, home delivery, and click-and-collect services, grocery chains have not only diversified their business models but have also reached a larger customer base. These adaptations have led to increased profit margins, which in turn benefits the investors through more substantial dividends.
While grocery retail stocks often demonstrate relatively slow growth, they compensate investors with lower volatility and high and stable dividends. These dividends serve as a reliable income stream, even in volatile market conditions, enhancing their attractiveness to income investors. Moreover, the reinvestment of these dividends can significantly contribute to total returns over time, thereby offsetting the lower growth typically associated with this sector.
Quality Dividend Stock: This Week’s Top Pick
The Kroger Co. (KR) is an American retail company that operates, either directly or through its subsidiaries, retail food and drug stores, supermarkets, multi-department stores, marketplace stores, and price impact warehouses throughout the United States. It also manufactures and processes food products for sale in its supermarkets and online; and sells fuel through fuel centers. Kroger belongs to the Consumer Staples sector (Industry: Consumer Staples Distribution & Retail).
Kroger, with its market capitalization of $33.7 billion and 2022 revenue of $148 billion, is one of the largest retailers globally; it is ranked #24 on the Fortune 500 list of the largest U.S. companies. The company’s grocery business is the second largest in the U.S. after Walmart; in the wider retail sphere, the supermarket giant trails only top-three players Walmart, Amazon, and Costco among the nation’s largest retailers by U.S. sales.
The Kroger Co. was founded in 1883 as a single grocery store in Cincinnati, Ohio. The company boasts a history of using innovative business practices since its early days. For instance, Kroger was the first grocer in the country to establish its own bakeries, followed by the integration of the meat department, thus establishing the concept of one-stop shopping. Kroger was also the first to use private-label manufacturing and one of the first to introduce self-service shopping and grocery deliveries. In the 1930s, Kroger became the first grocery chain to monitor product quality, as well as the first company with a store surrounded on all four sides by parking lots. In 1972, Kroger became the first grocery retailer in America to test an electronic scanner.
Ever since it was established, Kroger has continued to innovate and expand the range of services offered to its customers. The additional services benefit the company’s revenues and help it prosper in the highly competitive U.S. retail market. For instance, Kroger’s delivery business grew 22% in 2022, driven mostly by the national rollout of its paid subscription program Kroger Boost, helping the company to compete with the likes of Amazon Fresh and Instacart. In addition, Kroger is at the forefront of technological advancement compared to its peers: in recent years, it has been leveraging the power of data and analytics to boost sales and the customer experience. Moreover, in recent quarters the company has been implementing artificial intelligence tools, such as AI-based personalization.
Kroger has a long history of expansion through acquisitions and mergers. Beginning in 1955, Kroger began acquiring supermarket chains and merging with businesses addressing different markets. The company has also expanded its business with mergers and partnerships outside the brick-and-mortar of a grocery store. In 2014, it merged with Vitacost.com, one of the largest pure e-commerce companies in the nutrition and healthy living market. In 2018, Kroger merged with Home Chef, a subscription-based service that delivers meal kits; and also partnered with Ocado to cover the home-delivery niche. Today, Kroger Co. operates 2,750 stores in 35 states under two dozen banners, 170 fine jewelry stores, 35 food production or manufacturing facilities, 1,585 supermarket fuel centers, and 2,256 pharmacies.
The biggest merger in Kroger’s history up until now was in 1999, when it merged with Fred Meyer, the owner of Smith’s Ralphs, Food 4 Less, and QFC brands, in a $13 billion deal. However, a merger currently in the pipeline, if materialized, will substantially surpass it. In October 2022 Kroger announced that it had entered into a definitive merger agreement with Albertsons Companies, Inc. (ACI), wherein it will purchase all of Albertsons’ outstanding shares for a total value of roughly $24.6 billion. The deal is currently awaiting approval from the Federal Trade Commission (FTC). The government has been slow to approve the merger, fearing that a decrease in competition among grocery chains would add to food inflation pressures. Now that inflation displays a consistent downward trend, the deal may be approved in early 2024, as was originally expected by the merging companies.
While Kroger and Albertsons’ are the second and the fourth-largest U.S. grocers by market share, their shares amount to just 11% and 6%, respectively, as the grocery market becomes acceleratingly more competitive, pressuring margins and raising costs. If and when it is materialized, the merger will create a grocery company with $200 billion in annual revenues and 5,000 stores across the country, creating an opportunity for the combined brand to compete with the omnipresent Walmart with its 21% market share. The merger will help the combined brand to cut costs and offer competitive pricing. As there is no compelling reason for regulators to block the merger, apart from political considerations, Kroger’s CEO has committed to taking legal action if it is not approved. Whether the deal gets approval or falls through, Kroger will remain a longtime market leader in the grocery store business.
The Kroger Co. went public in 1977 on the New York Stock Exchange, trading under the ticker KR. The company began paying dividends in the same year but then suspended them to increase its expansion efforts. Kroger reinstated its quarterly dividend payments in 2006 and has been raising its dividends consistently ever since for the past 17 years. The latest such increase was announced in June of this year, with the payout increased by 12%; in 2022, the company upped its dividend by 24%. In the past three years, the dividends grew at a CAGR of 16%; the compounded annual growth rate of dividend increases since 2006 stands at a remarkable 13.7%. The company’s dividend yield stands at 2.3%, versus the sector’s average of 2.1% and the industry’s average of just 1.63%. With its reasonably low payout ratio of 24.2%, Kroger’s dividend payments are well covered by earnings, while the company retains enough profit to reinvest into the business to fuel its growth.
In addition to dividends, Kroger has been rewarding its shareholders with stock buybacks. KR has bought back 10% of its shares outstanding during the past five years. The company repurchased $309 million in shares during the quarter ended August 2022 and said in September that its board had authorized a new $1 billion repurchase program. However, in Q4 2022 the company’s management announced a temporary suspension of its share repurchase program ahead of its planned acquisition of Albertsons, aiming to use the additional cash to reduce its debt after the deal is finalized.
Kroger uses a high amount of debt to fund its aggressive growth and competition strategy but constantly works to reduce its debt burden. While Kroger’s debt-to-equity ratio of 104% is high, it has been reduced from 195% in the past five years and continues to decline. Besides, KR’s debt is well-covered by operating cash flow, while interest payments are covered by EBIT many times over. When compared to earnings, Kroger’s debt looks much more benign, standing at 1.4 times EBITDA.
Kroger’s capital allocation strategy focuses on utilizing its free cash flow to support long-term sustainable net earnings growth. In fiscal Q1 (ending May), Kroger grew its EBIT by 23% year-on-year, and that should make it easier to pay down debt. The company’s extraordinary cash-generating abilities support a favorable outlook for its balance sheet position. Thus, in fiscal Q1, KR’s net cash provided by operating activities grew by over 100% year-over-year; free cash flow surged over 400% in the same period. As for the capital efficiency and profitability metrics, Kroger boasts a Return on Equity (ROE) of 25%, almost twice the industry’s average. While the ROE is skewed by KR’s large debt, its high Return on Assets (ROA) of 6.1% (versus the industry average of 5%) underlines the efficiency of the company’s operation. Kroger’s net profit margin of 2.1% is much higher than the average (1.7%) for its low-margin industry. In the fiscal first quarter of 2023, the company managed to surpass analysts’ revenue and EPS projections, as it did in all quarters in the past years, with a single exception in Q3 2019.
Kroger’s stock is favored by Warren Buffett and his Berkshire Hathaway holding company, which holds about $2.5 billion worth of the company’s shares. Kroger’s stock is up 6.7% year-to-date, outperforming its industry, as represented by the Consumer Staples Select Sector SPDR Fund (XLP). KR has gained 40% in the past three years, versus XLP’s 22%. Despite Kroger’s outperformance, it is very attractively valued at a TTM P/E of 13.5 and a Forward P/E of 11.2, presenting over a 20% discount to the sector and a 50% discount to its industry’s average. No wonder, then, that hedge funds have been loading up on KR shares in recent months.
Analysts forecast an average 12-month upside of 11% for Kroger’s stock, which is rated a “Perfect 10” by TipRanks’ Smart Score system with a “Moderate Buy” recommendation:
To conclude, Kroger’s strong market position, aggressive growth strategy, multiple business growth catalysts, and cash-generating ability, coupled with its brisk dividend growth and low valuation, support its potential to provide steadily growing returns to shareholders. Therefore, we view Kroger as a compelling income investment.
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