"Stock Up" with This Company

04/26/2013 9:45 am EST

Focus: STOCKS

Richard Moroney

Editor, Dow Theory Forecasts

Still going strong after more than 100 years in business, this company is rewarding shareholders with increased dividend payouts, says Richard Moroney of Dow Theory Forecasts.

At Kroger (KR), growth is always in stock. Since Barney Kroger invested his life savings, $372, to open a grocery store in the late 1800s, Kroger has grown into a chain of 2,400 supermarkets in the US, operating under two dozen different names.

Nearly half of its stores pair with gasoline stations, while many are supercenters offering general merchandise, such as apparel and electronics. Through subsidiaries, Kroger also operates more than 780 convenience stores and 320 jewelry stores.

Kroger’s sales have increased in 26 consecutive years, helped by modest inflation, a handful of acquisitions, and steady organic expansion. Scoring above 80 in five of six Quadrix categories, Kroger earns an Overall score of 98, while both sector-specific scores exceed 95. The Forecasts initiated coverage of Kroger in the April 1 issue as a Buy and a Long-Term Buy.

Name-brand products share shelf space with Kroger’s corporate brands (about 26% of grocery sales). Unlike most grocers, Kroger manufactures about 40% of the products sold under its own brand.

The company separates its products into four main groups: nonperishable (50% of total revenue in the year ended January), perishable (21%), fuel (20%), and pharmacy (8%). All these groups have grown sales in each of the past three years, though none faster than fuel, up 111% from fiscal 2010.

However, fuel sales have contributed to the decline in Kroger’s gross profit margins, down for three straight years. However, operating margins widened last year.

Increased use of generic drugs has pressured Kroger’s pharmacy sales, but growth in prescriptions filled remains strong. Kroger is pushing further into health care, last year acquiring Axium Pharmacy Holdings, which offers specialty drugs and support services to patients with cancer, multiple sclerosis, and other chronic diseases.

By steadily taking market share from rivals, Kroger’s grocery business now ranks first or second in 38 of the 42 major markets where it operates. Same-store sales, excluding fuel, have risen for 37 straight quarters.

Kroger targets 2.5% to 3.0% higher same-store sales in fiscal 2014, with the slowest growth projected for the April quarter. However, unlike rival Walmart (WMT), Kroger says the April quarter started strong, with same-store sales growth exceeding 3% early in the period. Management expects profit growth of 8% to 11% this year.

Kroger has $1.19 billion in cash, versus long-term debt of $6.15 billion. Operating cash flow rose 7% to $2.84 billion last year, enough to cover interest expense six times over.

Kroger hiked its quarterly dividend 30% last year, and currently yields 1.9%. Management plans to raise the payout at least once a year in the future. Kroger has also spent more than $3 billion on buybacks over the last three years, lowering its share count by 20%.

The company targets long-term growth of 8% to 11% in per-share profits, plus a dividend yield of 2% to 2.5%, for a total return of 10% to 13.5%.

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