Kroger Treads Neutral Path

The Kroger Company (KR - Analyst Report) holds a significant position among the nation’s largest grocery retailers, and remains committed to battle the uneven recovery in the economy, and keep its head high, while treading the path.

The Company Counts Upon…

Kroger’s strong corporate and national brands help gain customers’ loyalty, sustain top-line growth, expand its store base and boost its market share.

The company’s customer-centric business model provides a strong value proposition for consumers and positions it well to deliver higher earnings, primarily through strong identical supermarket sales growth (sans fuel). Identical supermarket sales are expected to grow between 3% and 3.5% during fiscal 2012. The company’s customer 1^st strategy is also reaping results.

Management continues to deploy capital to concentrate more on remodels, merchandising and other viable projects. These include nearly 40 to 50 major capital projects comprising opening of new stores, expansions and relocations, and 125 to 140 remodels. Management continues to expect fiscal 2012 capital expenditures in the range of $1.9 billion to $2.2 billion.

Efforts Reaping Results

Kroger recently delivered better-than-expected first-quarter 2012 results, thereby prompting management to raise its fiscal 2012 earnings guidance.

The quarterly earnings of 78 cents a share beat the Zacks Consensus Estimate of 72 cents, and rose 11.4% from 70 cents earned in the prior-year quarter. Share repurchase activities provided a cushion to the bottom line. The increase in the bottom line came ahead of Kroger’s long-term goal of 6% to 8% growth.

The Cincinnati-based company now expects fiscal 2012 earnings between $2.33 and $2.40 per share, up from a range of $2.28 to $2.38 forecast earlier.

Total revenue (including fuel center sales) climbed 5.8% to $29,064.8 million from the prior-year quarter, but fell short of the Zacks Consensus Estimate of $29,194 million.

Excluding fuel center sales, total revenue rose 4.3% and identical supermarket sales (stores that are open without expansion or relocation for five full quarters) climbed 4.2% to $21,652.7 million marking the 34th successive quarter of increase.

Challenging Economy & Intense Competition

The economy is not devoid of risks, and Kroger is not immune. The intensifying price war among grocery stores to lure budget-constrained consumers may adversely impact Kroger’s sales and margins. The recent economic downturn and heavy job losses have transformed the way consumers used to shop. Cash-strapped consumers are now prioritizing their purchases, choosing cheaper substitute brands and shopping for groceries at low-price leaders like Wal-Mart Stores Inc. (WMT - Analyst Report) and Costco Wholesale Corporation (COST - Analyst Report).

The grocery business is highly competitive and fragmented, and Kroger faces intense competition from big players, like Supervalu Inc. (SVU - Analyst Report), and other conventional and specialty gourmet retailers with respect to price, store expansion, and promotional activities to drive traffic. This might weigh upon the company’s performance.

Further, higher debt-to-capitalization ratio also remains a major concern. Kroger ended first-quarter 2012 with a long-term debt (including obligations under capital leases and financial obligations) of $8,105.9 million, reflecting a debt-to-capitalization ratio of 66.6%, which is substantially higher, and could adversely affect the company’s credit worthiness and make it more susceptible to the macroeconomic factors and competitive pressures.

Closing Remark

The above analysis supports our unbiased view on the stock, and therefore we adjudge a long-term Neutral recommendation on Kroger, which operates 2,425 supermarkets and multi-department stores in 31 states under approximately 24 local banners. Moreover, Kroger’s shares hold a Zacks #3 Rank that translates into a short-term ‘Hold’ rating.