Here's Why Kroger Is Still a Buy

It's rare to see one of the world's largest noncyclical companies more than double the performance of the S&P 500 index in stock performance over a two-year period. Yet Kroger (NYSE: KR  ) has done just that, and compared to peers like Wal-Mart Stores  (NYSE: WMT  ) and Whole Foods Market  (NASDAQ: WFM  ) , there might be reason to believe that much higher days are ahead.

A reason for optimism
Kroger announced fiscal first-quarter earnings on Thursday and saw its shares soar 5% behind the report. The company reaffirmed its long-term net earnings-per-share growth rate of 8% to 11% and raised its full-year EPS guidance by approximately $0.05. As a result, shares are now in uncharted territory.

KR Chart

Kroger data by YCharts.

However, Kroger's two-year stock return of 117% may be just the beginning of a much longer-term trend of gains. There are two reasons for this prediction: growth and valuation.

Middle of the spectrum
Kroger lies in the middle of a spectrum that includes Wal-Mart on the high end and Whole Foods on the other. Wal-Mart is the world's largest retailer, and its growth is a fair reflection of the overall economy, as is its valuation premium.

Meanwhile, Whole Foods is one of the faster-growing major grocery retailers in the U.S., with a niche market in the organic and all-natural food category. Thus Kroger's growth and valuation premium should lie somewhere in the middle.

Strong evidence of execution
During Wal-Mart's last quarter, it reported total sales growth of 0.7% with comparable-store growth in North America flat year over year. The company's overall traffic declined 1.4%, and the only noticeable strength in North America was its e-commerce channel, which is growing at a 30% annual rate.

Whole Foods' revenue increased nearly 9% in its last quarter, although much of the growth was in connection to expansion both in the number of stores and in square footage per store. So on a comparable basis, its growth was only 4.5%, which lags the rate at which organic food consumption has grown in the U.S.

Meanwhile, Kroger, a company that should fall somewhere in the middle, grew revenue nearly 10%. Also, Kroger saw a 4.6% growth in identical-supermarket sales. Kroger defines a supermarket as identical when it has been open without expansion or relocation for five full quarters. For a company that already owns 20% of the U.S. grocery market such growth is fascinating, is outperforming both Wal-Mart and Whole Foods.

Is Kroger fairly valued, overvalued, or undervalued?
Yet despite Kroger's strong growth, margin improvements, and continued expansion with its supermarket concepts, the stock trades at only 14 times next year's earnings. This is almost identical to the S&P 500 and is just slightly better than Wal-Mart's 13.4 times forward earnings ratio.

KR PE Ratio (Forward 1y) Chart

Kroger P/E ratio (forward 1 year) data by YCharts.

Also, Whole Foods trades at 23.4 times forward sales, further showing a wide disconnect between Kroger's fundamental performance and valuation. In other words, due to the valuation premiums of both Whole Foods and Wal-Mart, we can rationally state that Kroger is both undervalued and poised to trade even higher long-term.

Foolish thoughts
Based on Kroger's fundamental performance, it is worth at least the same 23.4 times forward earnings multiple that's been given to Whole Foods; we can call this multiple Kroger's fair value. If we consider Kroger's long-term EPS growth guidance of 8%-11% and aggressive buyback strategy -- Kroger has repurchased 41.8 million shares over the last five quarters -- then the stock could easily double over the next couple of years while still staying attractive. For investors looking to limit risk with a quality noncyclical investment, this means that Kroger has to be atop the list of golden opportunities.

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