Kroger Earnings: Divestitures Planned to Stoke Albertson Deal Passage Amid Tough Environment
Narrow-moat Kroger KR shares moved up 3% on news it would divest 413-650 Albertson stores to competitor C&S, to meet regulatory concerns of its proposed acquisition of Albertson, allowing for a potential completion early next year. We still see regulatory uncertainty, though, as C&S stands to have 600-750 units, while the combined Kroger/Albertson would have a meaningfully larger 4,600 unit footprint. Apparently, the market concords with our view, with Albertson trading around $24 per share, below Kroger’s $34 per share cash offer.
We don’t see much in Kroger’s second-quarter results that would materially change our $55 fair value estimate, as slightly lower 2023 sales growth expectations are offset by a reset in our average fuel price forecast beyond this year. With shares trading around 10 times forward earnings, versus about 12 times on average during 2018-19, we see shares as undervalued.
Same-store sales (excluding fuel) rose 1% in the period, weighed down by an Express Scripts terminated contract at the end of last calendar year, a tough 5.8% year-ago comparison, and a value-seeking consumer in a food disinflationary environment (Kroger now sees food inflation ending the year at 1%-2% versus 3%-4% prior). Fuel averaged $3.65 a gallon in the quarter, down from $4.62 a year ago. With the environment expected to remain challenging, Kroger now sees same-store sales at the low end of its 1%-2% guidance for the full year, and we plan to adjust our 2% prognosis toward 1%. That said, we now see 2024-27 total revenue growth averaging 1%-2% versus 1% previously on higher fuel price expectations.
Despite higher promotions and shrink, Kroger’s gross margins increased 35 basis points to 21.8%. This is in line with our 2023 forecast of 21.7%, which is up from 21.4% in the prior year. Long term, we expect margins to remain around this level, as intense competition is offset by Kroger’s strong loyalty program, attractive private label offering, and industry scale.
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