Grocery chain Kroger (NYSE: KR ) operates in an extremely competitive industry, and the competition is only getting tougher as Wal-Mart (NYSE: WMT ) and Target (NYSE: TGT ) get in on the act. In fact, Kroger's traditional archrival, Albertsons, couldn't take the heat and was recently taken out by competitor SUPERVALU (NYSE: SVU ) . So is Kroger strong enough to survive?
The chain operates 2,500 grocery stores, which include namesake and Ralph's branded stores, as well as nearly 800 convenience stores, including the Loaf 'N Jug mini-mart. And so far, Kroger has successfully withstood the onslaught from Wal-Mart and the razor-thin-margin affair that is the grocery business. Second-quarter results released yesterday continue a solid string of high-single-digit sales growth and solid cash flow generation. Total sales grew 9.2%, while same-store sales grew 7.9% when gasoline sales are figured in (6% excluding gas), the 12th straight quarter of positive comps. Net earnings jumped a couple of cents from last year's quarter.
Fellow Fool Anders Bylund can walk you through further quarterly details in his Fool by Numbers piece. He also liked the strong sales growth for the quarter and reiterates that bottom-line profitability is minimal because of those tiny margins. However, Kroger is able to generate decent levels of operating cash flow. A good chunk goes toward capital expenditures, but the company also leaves room for debt reduction, share repurchases, and the payment of a dividend yield of 1.1% -- all shareholder-friendly initiatives.
Debt to capital is rather high for Kroger, at more than 60%, but thanks to stable cash flow, it can easily service its debt costs. Management expects earnings growth of 6%-8% for the next two fiscal years. In terms of shorter-term trends moving in the company's favor, management pointed out in the quarterly conference call that rising fuel costs favor grocery stores because of such stores' affordability and their proximity to consumers. The longer-term picture calls for growth similar to what's expected over the next two years.
Overall, I find it hard to get overly enthusiastic about Kroger. I see it as a very solid company operating in a tough industry -- an industry where only Whole Foods (Nasdaq: WFMI ) , despite a lofty P/E of 47, has been able to grow rapidly -- thanks to its niche focus on selling natural and organic foods to consumers willing to pay up for those goods.
Even with the Kroger's laser focus on controlling costs and its push for top-line growth, net margins are about 1.6%. To put that into context, discount warehouse operator Costco (Nasdaq: COST ) recently posted a 1.9% net margin, Wal-Mart a 3.2% net margin, and Target a 4.6% net margin.
Kroger and Wal-Mart may grow their top lines at similar rates that would be lucky to exceed 10%, but Target and Costco are growing sales and earnings in the low double digits, with arguably better growth prospects. It's a close call on Kroger, though; if the valuation came down more, the call would be easier, but from an opportunity cost, I think your dollar can go further with the newer retailing giants.
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