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Stock Analyst Update

Kroger's Management Making Prudent Moves

Although the deflationary environment is suboptimal, we are encouraged that the narrow-moat grocer posted stronger-than-expected margin performance.

Mentioned:

We do not plan to materially change our $32 per share fair value estimate for narrow- moat  Kroger (KR) after the grocer posted second-quarter earnings that leave the firm on pace to meet our long-term targets. Widespread deflation--a reflection of low agricultural commodity costs--led the company to post first-half 4.4% total sales growth and identical supermarket sales (excluding fuel) expansion of 2.1%, near our 5.4% and 2.7% full-year expectations.

Although the deflationary environment is suboptimal, we are encouraged that Kroger posted stronger-than-expected margin performance, with first-half merchandise costs at 77.4% of sales versus 78.2% in the same period of the prior year. We believe this supports our contention that Kroger benefits from a durable throughput-driven cost advantage, allowing the company to benefit from increasing tonnage even in a lower pricing environment. The firm’s attractive cost structure is difficult for smaller competitors to replicate as Kroger is able to leverage its distribution capabilities across a large store network, spreading inventory and supply chain investments over a large base.

In response to slowing top-line performance, the company announced it would reduce its capital expenditures for the year to $3.6 billion to $3.9 billion (from $4.1 billion to $4.4 billion). We believe the move is prudent given the deteriorating operating environment, and believe management's indication that it may instead be more aggressive in repurchasing shares could deliver value if the stock price dips further below our valuation. We continue to rate Kroger’s management team as Exemplary stewards of shareholder capital because of a strong track record of identical-store sales growth alongside excess returns in a competitive landscape.

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Zain Akbari does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.