A Beneficiary of Bad Times?

12/01/2008 10:49 am EST

Focus: STOCKS

Joseph Hargett

Financial Analyst, Schaeffer's Investment Research, Inc.

Joseph Hargett of Schaeffer’s Investment Research says an article on a supermarket chain prompts contrarian thoughts.

According to the Weekday Trader column on Barron’s Online, Kroger (NYSE: KR) "trades at a premium to the broader stock market on a price-to-earnings basis." However, the author, Johanna Bennett, justifies this premium by noting that the stock should continue to climb as Americans dine at home due to the worsening economic environment. Furthermore, the article, "Kroger Shares Deliver in a Downturn" (November 18th) states that, due to price-cutting measures taken in 2001, Kroger has remained quite competitive with Wal-Mart Stores (NYSE: WMT).

Analysts cited in the piece agree wholeheartedly with the bullish view of KR shares. "They deserve that premium," says Peter Kwiatkowski, manager of the Fifth Third Dividend Growth Fund. Additionally, David Strasser, an analyst at Banc of America Securities, who initiated coverage of KR at a Buy earlier this month, said that "shoppers are price conscious right now, and Kroger is in the right position."

But, while the article returns to the valuation concerns by pointing out that KR trades at a 30% premium to the Standard & Poor’s 500 index (SPX), Ms. Bennett remains firmly behind the optimistic outlook for the company. "Kroger has an edge over its rivals that will help feed profits. It also has a big pile of cash and a growing dividend. Investors looking for a good deal may want to stock up," she writes.

Kroger shares have indeed put in a strong performance relative to the broader market in 2008. The stock has logged a gain of about 1% since January, compared to the S&P's loss of more than 41%. What's more, KR is up more than 21% from its mid-October lows, and maintains the support of its ten-day and 20-day moving averages. However, the stock is staring up at staunch short-term resistance at the $28 level. The shares have closed only three sessions above this technical resistance since mid-August. (They closed below $28 Friday—Editor.)

Complicating matters further is KR's sentiment backdrop. While the stock's Schaeffer's put/call open interest ratio (SOIR) arrives at a mediocre reading of 0.75 in the 44th percentile of its annual range, call buying on the International Securities Exchange (ISE) and the Chicago Board Options Exchange (CBOE) has risen sharply in recent days. Specifically, the ten-day ISE/CBOE call/put ratio rests at 4.66 and is higher than 85% of all those taken during the past year.

Meanwhile, analysts are extremely bullish toward KR. According to Zacks.com, nine of the 11 brokerage firms following the shares rate them a Buy or better. As long as the firm continues to impress Wall Street, this sentiment (bullish analysts and bullish options traders) shouldn't matter too much. But as soon as KR slips and confidence in the company's ability to weather the economic downturn wanes, we could see unwinding of this optimism [hurt] the shares.

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