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Dillon Jacobs

13 Sep, 28 tweets, 10 min read

1/ In this week's Stock Spotlight, I took a look at Kroger (KR).

I actually came away surprised after my analysis.

In this thread, I will be explaining why $KR is the safest grocery stock you can find on the market.🧵👇

2/ History 🕮

The Kroger story actually began in 1883 in my hometown of Cincinnati, Ohio.

Mr. Barney Kroger invested his entire life savings into opening his store downtown.

Mr. Kroger put his main focus on quality products, while delivering excellent prices to his customers.

3/ Mr. Kroger was the inventor of “one-stop-shopping”.

He figured out that if he opened his own in-store bakery, he could lower the prices for customers and keep quality high.

This lead to added convenience and profits for both parties.

4/ Present Day Operations 🏪

In 2021, $KR has grown to a colossal sized American grocer, with 2,742 supermarkets operating under several banners throughout the country.

Around 82% of stores have pharmacies, while over half also sell fuel.

5/ The company also operates more than 150 fine jewelry stores, 35 manufacturing plants, 220 clinics, and 2,200 pharmacies.

$KR features it’s leading private-label brands and manufactures around 30% of its own-brand units (and 40% of its grocery own-label assortment).

6/ $KR is a top-two grocer in most of its major markets, only trailing behind $WMT.

Virtually all of $KR sales come from the US.

7/ The grocery business is a notoriously low-margin business, thus most investors don’t tend to gravitate to them.

They are perceived as slow growing and boring.

This is not an untrue statement. Take a look at $KR's margins over the past decade.

8/ I can understand why investors wouldn’t be thrilled with sub 30% gross profit margin, and around a 2-3% net income margin.

There is not a lot of room for error here.

This begs the question: can $KR still grow it’s business while operating such thin margins?

9/ Growth Drivers🌱

$KR’s digital business remains one of its key growth drivers, especially due to the pandemic.

$KR has invested in its fulfillment centers in order to facilitate this new wave of commerce, with over 2,200 pickup locations and 2,400 delivery locations.

10/ Additionally, $KR has recently partnered with the online British grocer Ocado, to create brand new delivery facilities in Florida and Ohio.

$KR also recently announced a pilot in partnership with Drone Express, to eventually leverage drone delivery to customers.

11/ $KR is embracing smarter advertising and AI solutions in order to give customers the best possible experience and cut costs.

This has allowed them to save cash with the “Restock Kroger" program, management is targeting margin-rich alternative profit streams.

12/ The Restock Kroger program saved the company over $1B in 2020.

Interestingly enough, the company recently announced a $1B stock buyback, no doubt coming directly from these savings.

13/ Of course, as a grocery behemoth, M&A activity is critical strategy for $KR to maintain market share and scale.

$KR has completed plenty of M&A’s over the past 15 years, and seems to average 2-3 per year.

14/ Risks❗

Since the grocery business is one that serves everybody, it is a naturally very large and fragmented industry.

$KR faces intense competition from traditional big players such as Walmart, Albertsons, and Safeway.

15/ It also has to deal with the online e-commerce giant, $AMZ. Not only for groceries, but at other brick and mortar locations, with Whole Foods.

16/ Margin Control 📉

Thin margins leaves very little room for error when it comes to profitability.

To counter this, management has to have actionable plans for volatile food prices (like we are seeing now) in order to make it out with some cash left over.

17/ Leadership 🧑‍💼

Mr. William Rodney McMullen is the current Chairman & CEO of $KR.

He has maintained a super-tenured status with $KR, after first joining the company as a part-time store clerk all the way back in 1978!

18/ As the nation’s second largest grocer, $KR is unsurprisingly 76% institutionally held.

Interestingly enough, Warren Buffett (through Berkshire Hathaway) owns over 8% of the company.

Of note, the CEO owns just under .5% of the company, or around $145M.

19/ ROIC and Profitability📊

$KR has seemingly always been able to generate pretty high ROEs, with decent ROICs.

However, ROIC has been trending downwards a bit over the past few years, which is a bit troubling to see.

Nevertheless, I am pretty happy with these numbers.

20/ Rewarding Shareholders 🎁

$KR rewards its shareholders the old fashioned way: paying dividends and buying back shares.

The company plans grow earnings, but a mature and stable company like $KR will be offering value to shareholders primarily through dividends and buybacks.

21/ Capital Allocation 💰

As you can see, inthe past couple years the company has prioritized growth CAPEX over maintenance CAPEX.

Management seems to focus more on the digital acceleration as well as margin expansion, which is exactly what I want to see out of this company.

22/ Free Cash Flow💵

$KR has been able to grow FCF at a rate of about 10% per year.

2020 saw a huge spike in cash generation, due mostly to the pandemic.

Since we have started to reopen, FCF has fallen back down to normal levels.

23/ Given this large spike in FCF, $KR's P/FCF went to a decade low of 8x, making the stock look cheap.

The share price gradually caught up to the FCF, and now sits at normal levels of around 15x-20x.

24/ I think it is likely that $KR will continue to grow FCF about 11%, or the higher range of what management expects shareholder returns to be.

I suspect growth will slow to 8%, which will hopefully account for both positive and negative scenarios.

25/ To be honest, I think that the stock is pretty fairly valued and could even be undervalued.

My calculation does not take share reduction into account, which $KR has done aggressively over the decade.

26/ Conclusion ✔️

I think $KR is a solid company.

I am impressed to see that you can buy it at an affordable price right now.

What’s more, it seems be a really nice hedge against market volatility, as the stock price didn’t even flinch during the March 2020 crash.