Top grocery companies Kroger (NYSE:KR), Whole Foods Market (NASDAQ:WFM), Sprouts Farmers Market (NASDAQ:SFM), and SUPERVALU (NYSE:SVU) have all seen weakness in 2014. However, with grocery being non-cyclical and outperforming the retail sector, might investors find upside in this weakness?
Big, cheap, and growing!
Kroger is the largest pure grocery store in the United States with $99 billion in annual sales. The company has a three-year annualized revenue growth rate of 8% versus 1.7% for the industry and has achieved this growth due to its customer-loyalty program. Depending on where you live, those rewards include points for purchases that can be used on fuel or, in some states, cash back. The benefits for being a member include special pricing on many of the items; and with Kroger's growing food brand, it has been able to increase margins consistently.
For this consistency, expected growth of 6.6% this year, and store upgrades that are making Kroger a diversified retailer, investors pay just 12.5 times earnings, or about 0.2 times sales. In 2014 shares have fallen 5.5% -- although still up 34% over the last 12 months -- meaning Kroger could be poised to recover nicely.
A lot of promise, but a lot of problems
SUPERVALU focuses solely on the discount-grocery business and at one time was significantly larger than Kroger. Last year it completed the sale of its Albertsons, Acme, Jewel-Osco, Shaw's, and Star Market stores, which essentially cut annual sales in half to $17 billion.
Today, SUPERVALU operates mostly Save-A-Lot grocery stores but lacks growth, has a heavy debt burden, and lacks profitability. Yet, the one thing SUPERVALU has in its favor is its valuation along with the upside that could be created by becoming smaller and focusing on its more efficient stores.
Obviously, a major restructuring program is taking place, and if effective, very large gains could be created from this stock, which trades at just about 0.1 times sales. However, with an accumulated deficit of more than $3.2 billion, significant downsizing or an eventual bankruptcy are possible outcomes as it relates to this company.
Whole Foods is a natural- and organic-foods supermarket, a focus that has grown increasingly popular throughout the U.S. with a more health-conscious consumer. Its $19 billion market cap makes it the most valuable organic/natural food-focused grocery company in the U.S.
Yet, with annual sales of $13.3 billion, it's far from having the same presence as Kroger. However, at 35 times earnings and 1.4 times sales, the company trades at a steep premium to Kroger.
While the organic- and natural-food market is outperforming the overall grocery sector, it doesn't appear that Whole Foods' 12.8% three-year annualized revenue growth rate makes it deserving of such a steep premium to Kroger. Thus, despite a 10% loss in 2013, it is still not presenting value relative to the sector.
Great promise, but is valuation a concern?
Sprouts Farmers is new to the public market, becoming public in August of last year and now trading with losses of 9% in 2014. Sprouts is the ultimate investment for growth in the natural and organic space, as its $2.3 billion in annual revenue makes it significantly smaller than Whole Foods. Yet, like Whole Foods, it trades with a premium: a market cap more than $5 billion and a price to "future" earnings of more than 60.
Clearly, investors like the growth prospects associated with Sprouts, a company expected to grow 16.8% in 2014. In particular, Sprouts operates 160 stores versus Whole Foods' 360, but it's worth noting that Sprouts averages about $14.4 million per store while the latter creates nearly $37 million for each store.
As a result, there are many questions regarding whether Sprouts can grow and take market share from Whole Foods or increase its revenue-per-store at existing locations. Not to mention, large competitors such as Kroger and Wal-Mart are stepping up their efforts to become more relevant in the organic-food market, which could drastically affect smaller names like Sprouts. Given these risks, it's hard to support an investment with such a lofty valuation.
Grocery stocks have in part fell due to weak overall retail sales in 2014; but it's worth noting that despite a 0.4% loss in January retail sales, grocery rose 4%, thus showing that losses may be overblown. As a result, if you find the right stock, large gains could be created.
In looking at these four grocery leaders, all have upside associated with their stocks. However, for the two operating in organic and natural foods, an unfair premium has been awarded, which could limit upside for long-term investors.
SUPERVALU does have upside, but there is still a great amount of uncertainty and risk associated with the stock. Therefore, Kroger looks like the best stock in this class by far. It is cheap, has growth, and a solid long-term outlook due to its loyalty program and store expansions into other facets of retail.
Hence, in a cheap industry, Kroger might be the most attractive of the bunch.
John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.