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Kroger Sees Margins Contract

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Kroger Co. ([url=]KR[/url]) reported better-than-expected results for the second quarter of fiscal 2008. Sales were $423 above consensus estimates, while its EPS were $0.01 ahead of the consensus. Despite the strong second quarter results, Kroger maintained its full-year EPS guidance of $1.85-$1.90. We are increasing our sales and earnings estimates to reflect the upside in the second quarter.

The combination of company’s low prices and private-label brands are leading to market share gains and driving the company’s results. Still, we remain concerned with Kroger’s contracting gross margins and higher food prices that could cause consumers to trade down from Kroger stores. The stock looks fairly valued at current levels. We maintain our Hold rating.

Kroger shares are trading at 14.5x our fiscal year 2008 EPS estimate and 12.8x our fiscal year 2009 EPS estimate. We think this valuation is fair and believe the stock’s performance over the next six months will track the return of the S&P 500. As such, our target price is $29, or about 15x our fiscal year 2008 EPS estimate.

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